THE IMPORTANCE OF GOOD MANAGEMENT WHEN SELECTING INVESTMENTS
Mark Lister, 22 March 2021
Of all the attributes and qualities to look for when deciding whether to invest in a company, how important are the people in charge?
There are many things to consider when seeking out the best share investments - a strong balance sheet with modest debt levels, a competitive advantage, a dominant market position, high quality assets, growth potential and strong operating cash flow.
However, all these things can become meaningless if you can’t point to strong, competent, trustworthy leadership.
I remember the day Steve Jobs announced his resignation in 2011. The Apple share price immediately fell, highlighting the concern investors had over how the company would fare in his absence.
In the ten years since, Apple has continued to succeed. Jobs had built a strong team around him and despite the fact he was the public face of the company, his legacy of innovation continued. His successor, Tim Cook, had a long, successful career at Apple working closely with Jobs.
Similar speculation surrounds how Warren Buffett's company, Berkshire Hathaway, will manage when he's no longer fit enough to run it. The legendary investor is still Chair at 90 and his long-standing right-hand man, Charlie Munger, is 97.
When that day inevitably comes, I’m willing to bet the Berkshire share price will fall in response. However, the real test will come in the years to follow, as we find out just how good Buffett’s succession planning has been.
In New Zealand, there are many instances of less than perfect governance.
One notable recent case is that of a2 Milk, with the brief stint of former boss Jayne Hrdlicka riddled with examples of how not to manage a difficult situation.
Fletcher Building and Fonterra have also had their fair share of poor leadership in recent years, which has contributed to a mixed financial performance and unsatisfactory outcomes for shareholders. Thankfully, both companies are under more astute management today, and performance has improved.
At the other end of the spectrum, we have a plethora of well-managed businesses that have delivered consistent returns for shareholders and managed leadership transitions with ease.
Fisher & Paykel Healthcare, Meridian Energy, Freightways, Auckland Airport and Ryman Healthcare are a few that spring to mind.
While it’s clear that leadership is important, a harder question to answer is how we should measure these qualities.
A company's quantitative and financial factors are comparatively easy to see and judge. Debt levels, profit margins and historic growth rates can all be calculated, and some ratios or forecasts churned out. The value and skills of management are much less tangible and harder to assess.
In many ways actions speak louder than words. We look for company leaders who are focused on delivering shareholder returns, know their businesses intimately, have a track record of success, and communicate openly with shareholders.
Many successful companies have executive teams that have been stable for a long time. While a fresh approach can revitalise a business, continuity is also important, so we look for companies where a reasonable proportion of the senior team has been there for a reasonable length of time.
We look for management that has a history of doing what it says it will, and backing up forecasts with results. Businesses are influenced by a range of factors and many of these are unpredictable, although questions must be asked of those that regularly miss forecasts.
Another good sign is when those in leadership positions have their own money in the business. There is no substitute for having skin in the game, and this further ensures that management share successes and failures with shareholders.