While financial statements provide detailed insights into a company’s prospects, future performance is significantly impacted by the business’s management – regardless of size, structure or industry. The quality of the Chief Executive and senior managers is critical to assessing the overall value of an enterprise and is one of the most important factors informing our investment decisions.
Our investment approach is based on a detailed rating system for measuring a company’s intrinsic value and determining if it is a viable investment proposition. We rate both quantitative aspects of the company, such as forecast Earnings per Share (EPS) growth, and qualitative attributes, such as management. So how do you measure the value of a company’s management team?
1. Verbal and non-verbal communication
We seek out information about a company’s management from a range of sources including ASX announcements, company reports, media articles, analyst research and industry sources. But we gather some of our most valuable data from face-to-face meetings and briefings. As an investment manager, we invest in more than 90 companies at any one time and over the course of a year, our investment team has more than 1,000 meetings with the individuals who run these businesses.
Meetings provide us with the opportunity to gain an immediate and potent impression of the people who run a company. Observing their body language and overall demeanour can be incredibly insightful. For example, a lack of eye contact or crossed arms may signal that what they are telling us is inconsistent with reality. We may meet with the same managers many times over several years. This allows us to develop a rapport and understand nuances in their body language, tone and demeanour and, when we detect changes, this can be an important indicator.
2. Track record of success
As the saying goes, “past success is the best predictor of future success” and this holds true when evaluating a company’s CEO and management. In fact, when a board appoints a new CEO (and management team) with a track record of strong performance, this can be a catalyst for us to invest. In our experience, when a company is underperforming, management is by far the most important factor in achieving a turnaround in its fortunes.
When Simon Baker was Managing Director and CEO of REA Group Ltd (ASX: REA), owner of online real estate advertising portal realestate.com.au, he achieved great success with the company. During his tenure, REA’s share price rose from an IPO price of 50 cents to around $3.80 a share. In 2009, Simon joined Malaysia-based iProperty Group Limited (ASX: IPP), servicing the burgeoning Southeast Asian property market. We had great faith in his ability and factored this into our decision to invest in the company. While iProperty shares listed in September 2007 at 25 cents each, in recent weeks the company received a bid by REA offering shareholders $4.00 a share.
Similarly, in 2013, the team leading Flexigroup Limited (ASX: FXL) departed after growing the company and driving the share price from 31c a share to above $4.85 per share. They joined Eclipx Group Limited (ASX: ECX) and have had similar success, with the company’s share price increasing from a listing price of $2.30 a share in April 2015 to around $3.40 today.
3. Alignment of remuneration and incentives
It is absolutely paramount that management’s interests are aligned with those of its shareholders. This is achieved through incentive structures that motivate managers to make prudent decisions that benefit the company and not themselves. The appropriate base salary, bonus structure and performance hurdles are required to ensure the business’s leaders successfully manage the company to achieve sustainable growth. Ideally, performance targets should be a mixture of EPS, which focuses on driving profit, and Total Shareholder Return (TSR), which is related to share price performance. In our experience, over 17 years of investing, the wrong incentive structure can have dire outcomes for the company’s investors.
It is also important to ensure good quality managers are incentivised to remain in the business. If management has some serious ‘skin in the game’ through equity in the company, it further aligns their interests with those of its shareholders. Good examples of this are Jamie Pherous, Managing Director at Corporate Travel Management Limited (ASX: CTD), and Adrian Di Marco, Executive Chairman at TechnologyOne Limited (ASX: TNE).
4. Leadership style
We assess management by evaluating the leadership style of the CEO and individual managers, looking at their ability to layer management, reduce costs and importantly how they cultivate a positive culture and empower their team.
Numerous research studies have shown there is a correlation between corporate culture and a company’s financial performance. For example, in 2001, Eric Flamholtz from the University of California at Los Angeles found organisational culture had an impact on both a company’s effectiveness and the ‘bottom line’. In addition, Hewitt Associates and Barrett Values Centre conducted a study of 163 companies as part of the 2008 Best Employer study and found that “… employee engagement significantly influences organisational and financial performance.”
We can assess the culture based on small but insightful details. For example, observing during a site tour whether the manager knows their employees by name and how they interact.
5. Consistency of ‘story’ over time
We have meetings with the management team of the companies we invest in at least once every six months and we ask some of the same questions every time. If the company’s script changes it raises a concern that they are not on the same path and have altered their strategic point of view.
A disciplined approach to executing the company’s strategy over time and consistency of approach are important factors to measuring management’s ability and gauging if they’re trustworthy.
Chris Stott is Chief Investment Officer at Wilson Asset Management. Disclaimer: Listed Investment Companies managed by Wilson Asset Management invest in IPP, ECX and FXL. This article is general education and does not address the needs of any individual.