When you begin to consider new companies to invest in, one of the very first things you should look for is a good management structure.
Recently, we reviewed the excellent The Little Book That Builds Wealth by Pat Dorsey for our Five Minute Read series. In it, Dorsey outlines the different ways in which companies with economic moats can generate excessive returns for shareholders over the long-term.
One element of Dorsey’s theory that I found interesting is how little weight he gives to good management when assessing companies. It’s his view that regardless of management, a company with a strong economic moat will perform well – while those without one will struggle, even under a great manager.
I have to disagree with Dorsey on this point. In fact, I actually place a huge amount of importance on the management of a company I’m considering investing in because I believe that great managers can actually create competitive advantages over time.
One example that immediately springs to mind is Reed Hastings with Netflix.
When Netflix evolved from mailing out DVDs into the world of online streaming, they had a first mover advantage. But it quickly became obvious that this wasn’t going to be enough.
They were a small player in the media landscape, and at the time, a number of bigger rivals could have come in and ended the parade pretty quickly. It was a commodity business – with content being the commodity – so whoever had the best content was going to attract the most customers.
In that sense, Netflix probably benefited greatly from inept competition in those early years. But if capitalism works – as we know it does – that wasn’t going to sustain the company in a multi-billion dollar market long-term.
Hastings realized this and went on to turn Netflix into a content generator – a move that many were initially hesitant about. Fast forward to today, and Netflix has created its own unique economic moat due to a plethora of high-quality original content like House of Cards, Narcos, and Stranger Things (which was actually rejected by about 15 networks before Netflix took it onboard).
It’s important that you get a sense of a company’s management before investing. After all, when you invest in a company, you’re essentially betting that the CEO can do better with your money than you can.
So how do we go about assessing management?
Assessing Company Management
From a purely quantitative standpoint, you can look at things like return on capital – for every dollar that goes into the business, how much money is being generated? That’s a good sign that management are effective capital allocators, and that money is not being wasted.
Recently we added Brown-Forman to the Showroom, a company that has consistently generated high returns on capital for well over a decade. That to me shows management is doing something right.
You could also look at how much value a manager has created for stockholders in the past. Before Steve Wynn started Wynn Resorts, he was the CEO of Mirage Resorts. During those 27 years in charge, Mirage Resorts generated an incredible 25% annualized return for shareholders. A $10,000 investment in Mirage Resorts would be worth over $4 million at the end of his tenure.
That’s the kind of person I want managing my money.
But both these methods only look at what’s happened in the past. As we all know, the stock market is only concerned with what’s going to happen in the future. So how do we assess how a manager will perform going forward?
This is where it becomes a lot more instinctual.
You should try to get an overall sense of the person in question. If the CEO is also the founder, it’s great to dig into the story of how they started the business – what obstacles they faced, and how they overcame them. There’s usually profiles of successful entrepreneurs published in the likes of Forbes and Fortune magazine.
NPR recently started a new podcast called ‘How I Built This‘, which I would recommend to anyone interested in entrepreneurs. So far, the only guest they’ve had from a company in our Showroom has been Jim Koch of Boston Beer, but I’m sure they’ll have more in the future.
If the CEO is not the founder, you can get a good grasp of their past experience by checking out their LinkedIn page. You’ll notice a lot of CEOs come from vice president positions in big companies like PepsiCo and Ford. These are positions usually reserved for high achievers, so it’s always a good sign to see on a resume.
Glassdoor is one of our more recent tools for assessing business leaders and is a brilliant resource for finding out what the staff thinks of their boss. Great CEOs inspire their workforce and when a company is doing well it creates a good working atmosphere.
Interestingly, if you check out Glassdoor’s top-rated CEOs, you’ll find many of the companies we recommend in our Showroom.
You should try to watch or read interviews with the person in question. You’ll find plenty of footage online of the likes of Warren Buffett, Kevin Plank, Elon Musk and Bob Iger. This may prove difficult or smaller companies, but you can always listen to them during the earnings call – which most do every quarter and can be found on the company’s investor relations page.
When assessing a CEO’s character, you should be asking yourself whether this person seems competent and suited to the role. I always like to see that a CEO has a long-term vision for the company and that his actions are aligned with that vision.
Finally, you want someone who seems honest and has a lot of integrity. Remember, it’s your money you’re trusting this person with. Managers that speak candidly and admit their mistakes rather than passing the buck are always a welcome sign when it comes to investing.
If you’re able to put your trust in a good CEO, you’ll be far better equipped to ride out any downturns and benefit from the upside of long-term buy-and-hold investing.
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