“In the business world, the rear-view mirror is always clearer than the windshield,” Warren Buffett
The quality of management can make or break an investment decision, says master investor Nemish Shah, co-founder of Enam Capital.
Management integrity always pays off handsomely over time, says R Balakrishnan, co-founding member of CRISIL.
Judging people is overrated. Judging track record is underrated, says Anand Sridharan, investor Nalanda Capital.
Look at the track record of the management. At least two market cycles (ups and downs) to distinguish skill from luck.
How the average investor can assess the quality of a management? You may use the following checklist to judge people.
1. What management has achieved over a long period of time?
For example, built a dominant brand, strong franchise, low-cost producer, large network, self-funded growth.
2. How well the management has allocated capital?
Return on Capital (ROCE) >= 15% (10-Year Average, higher the better)
Return on retained earnings
3. Does the company have a strong balance sheet?
Debt to Equity (D/E) < 0.8 (10-Year Period, lower the better)
Working capital days, receivables days (lower the better)
Avoid high debt
4. Does the company generate strong cash flow?
Positive cashflow (10-Year Period)
5. What is their competitive position?
Market leader, challenging the leader, high market share.
6. What risks the management has taken?
M&A, bought low return business, diluted equity
7. What risks the management has avoided (not taken)?
Avoided M&A (expensive buying), avoided non-profitable tenders
8. How well the management treat minority shareholders?
Promoter Holding > 40% (higher the better)
Admitting mistakes, delivering bad news first, mentioning risks, not hyping up the future
9. Has the company consistently outperformed peers?
Earn high return on capital, high-profit margin (higher the better)
10. How this business differs from peers?
People, reputation, behaviour, communication, conservatism, competitive position and industry nature.
11. Do you see potential red flags?
Look at quantum of ‘related party’ transactions, ‘salaries & commissions” to family and friends, number of not fully owned subsidiaries/associates, capital market reputation.