Saturday, December 15, 2012

Assess the Quality of Management-Summary of Chapter 8 Investment Checklist

Note: Most of the summary below are derived from Mr. Michael Shearn's book "The Investment Checklist". You can find the information on this book from I will not personally take any credits for the summary below. 

Assess the competence of management.

John Mackey of WFM has coined the term conscious capitalism to describe business designed to benefit all of their stakeholders, such as customers, employees, investors and suppliers. Robert Wilmers, CEO of M&T Bank, lived a business philosophy that could be a primer for sound banking: "know your markets and employees, watch credit quality relentlessly, don't gamble with interest rates, and focus on serving your community."

I. Does the management team improve its operations day-to-day or does it use a strategic plan to conduct its business?

  • Most successful businesses are built on hundreds of small decisions, instead of on one well-formulated strategic plan. They build their business day by day, focusing on customer needs and letting these customer needs shape the direction of their businesses. 
  • Another common theme among businesses that improve day by day is that they operate on the premise that it is best to repeatedly launch a product or service with a limited number of its customers so that it can use customer reactions and feedback to modify it. 
  • You need to determine if the management team you are investing in works on proving a concept before investing a lot of capital in it or whether it prefers to put a lot of money in all at once hoping for a big pay off. 
  • Strategic plans fail because they often shut out other opportunities. When an opportunity comes up and it does not fit into the strategic plan of a business, then the management team will likely pass it up. The truth is that most management teams often stumble upon their best ideas. 
  • The strategic plans that are most prone to failure are those that have an overly narrow focus, such as those that set a financial target. What happens in most of these cases is that when the CEO focuses on a specific financial target, they neglect other areas or take on more risk. GE's 29% market share goal in 2003 make them burn billions of dollars and launch new models in too many market segments which they can't adapt quickly enough to make money. Continental Bank in 1976 was the 8th largest bank and they laid out goals to become the largest lenders. They started aggressively pursuing borrowers and took more volatile foreign deposits, loosened lending criteria and relaxed documentation standards. It was bailed out in 1984. 
2. Does the business value its employees? Check 

3. Track management's record in share repurchases, disregarding shares repurchased to offset options dilution. 

4. Positive and negative traits of management:
  • Public interviews are among the best sources for real insights, as are in-depth articles written about the managers. 
  • Whether they have remained in the same industry for a long period of time or if they jump from industry to industry. 
  • Managers who are truly passionate about their business have less time for outside social engagements. 
  • Often times, you can infer the motivation of managers by the number of large social or charity events they attend. 
  • Can you identify a moment of integrity for the manager?
  • You gain more insight into management when conditions are adverse than you do when circumstances are ideal. 
  • The best managers are those who, during adverse conditions such as the one in 2007, disclose more information so their shareholders could better understand the operations of the business and what the management team was doing to cope with the difficult economic situation. 
  • The best managers also quickly and openly communicate how they are thinking about the problems and outline how they are going to solve it. Robert Silberman of Strayer Education disclosed that new student enrollment had dropped 20% in the 2010 winter term, the largest drop that Silberman had seen in his tenure. Even though he did not know the exact reasons, he reported this negative news to shareholder the moment he had the information, and then he held a special conference call first thing in the next morning to answer questions and explained how he was reacting to it. Similarly, Jamie Dimon of JP Morgan disclosed very honestly right after the CDS trading loss in 2012 and reacted promptly. 
  • Whether the tone of the annual report is consistent with the business performance, for example, if the business had a mediocre or horrible year and the annual report started with the positive things, it's a red flag. 
  • If managers remove the scripted sessions from the earnings conference call, this is a positive sign because this indicates that managers want to address shareholder questions or concerns, such as Penn National Gaming's CEO Peter Carlino. 
  • Most of the time, there's no proprietary information regarding marketing, historical merger and acquisitions, personnel, or legal issues. If the unanswered questions have to do with specific financial guidance, that is okay. 
  • Does the manager use double speak (i.e inconsistency). 

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