If you are investing in the stock market and in particular small & mid-cap companies, evaluating the company’s management is of prime importance. I will try to explain the checklist on “How to evaluate a company’s management?”
Let's first start by "Why do we need to evaluate a company's management"?
Everything in a company boils down to the company’s management. It is them how they take the company from ordinary to extraordinary as well as from ordinary to worse.
Management in a company is capable of taking the path of Eicher, Page Industries etc or that of Satyam computers, PC Jewellers, Vakrangee etc
Since the management is the decision & policy maker, it boils down to what steps they take.
I always believe in the quote that ‘A company & its team are just a reflection of the leader’s or management team’s personality’.
How a salesman is treating the customer, how seriously & promptly the company takes your service request, how does a hospital deal with patients are more or less an indication of the leadership’s thought & integrity?
All laws of life are applicable to the stock market.
Why is it so important?
The idea is that you should not lose your capital.
As long as things are going fine, there are no issues. But as soon the misdeed comes to light, you will not get any time to liquidate your holding and the entire value of the company will be lost in no time. Always keep an eye out for this.
Also, it’s more qualitative than quantitative. One needs to build their own judgment based on their understanding.
Let me first define some terms which will help you make more sense out of this blog.
Promoters: They are the owners of the company. Most often they are the ones who have started the company.
Management team: They are mostly the promoters & their relatives who look after the day to day of the operations of the company.
Professional management: These are people from outside of the company’s brought in to look after the day to day operations as well as grow the company.
I will be using Promoters or Management team interchangeably. In the case of Professional management, I will quote it differently.
Before I get into the depth, I would like to stress on one point that for similar scams, if it is due to someone else other than the top management it won’t affect the company much. The other employees can be easily replaced but if the management team is found doing slightest of such stuff, it tarnishes the image of the company & puts a question mark on the entire operations of the company.
For eg in National peroxide top-level employees (NOT the management team or the promoters) siphoned off about ₹37 crore slowly over a period in the company. Although the amount is huge given the size of the company but the negative impact on the share price was short lived.
Lets look at the ways one can evaluate a company's management?
1. Read the annual report: I am not saying to read the entire report(more than 100 pages each) but just these two sections“Director’s Report” & “Management Discussion & Analysis”. It would hardly be 3-4 pages for each year. So if you read 5 years annual report it would be max 20 pages.
Now what to look into while reading the Annual report: Director’s report mainly gives commentary on the financial performance of the company whereas Management Discussion & Analysis gives us the business overview.
While reading I start from the oldest to see what all comments & future plans have been promised by the company & how have they acted. Gives a lot of indication on the proactive nature & whether they adhere to their words.
How to get hold of the Annual reports: All listed company’s website has a section called “Investor relations”. I am sharing the link of VIP Industries website where you can see the link to “Investor Relations” as the 4th item on the heading.
2. Listen to conference calls: It’s not mandatory & not all companies discuss the results with analysts. You can check if there are any conference calls recorded in an app called as “Researchbytes”Here you can search the company & then listen to the call in “Analyst Meet & Calls” section.
When you listen to the calls you need to see how forthcoming are the management team with details & how they react to uncomfortable questions.
3. Watch management interviews: Youtube is a very good source. Whichever company you are researching on, just search the name of the company on Youtube or the top management. And observe the same point mentioned in Step 2.
4. Warrants: Avoid companies that tinker a lot with the capital structure. Warrants are a tool allowing the company’s management to issue shares at a price that they can decide. Management will have the right to buy shares at a pre-specified price within a certain timeframe & they need to pay only 25% of the total amount upfront.
Warrants can also be a tool to infuse fresh capital into the company. There are 2 ways to determine the genuineness of issuing warrants:
a) Does the company really need capital- Required if the company is into losses or need capital to grow?
b) What is the price at which warrants are being issued- It should be more than the prevailing market price given the option of buying within a time frame.
5. Mergers & Acquisition:
Is the acquisition in a similar field as that of the business of the company? Unrelated acquisitions divert management focus.
What is the price being paid for the acquisition? You can google & read about it.
If taken by so-called professional management, it’s mostly done to be in the limelight or to show to the promoters that they are really doing something.
6. Payment made to auditors:
If the payment made to auditors are high, that would mean that they are being paid to hide something.
For a mid or small sized company, it should not be more than 30-40 lakhs. In the case of Satyam scam, it’s auditors PWC was found to receive very high payments.
7. Avoid companies with huge debt: When the company has huge debt and something goes wrong, there is a spiraling effect impacting the entire operation of the company.
With huge debt comes huge interest payments. If the company is not able to pay the interest, then it would worsen its ability to pay salaries, pay suppliers & the list goes on.
8. Promoters stake in the company: Promoters are the owners of the company. High promoter stake would mean their skin in the game. If the promoters are selling their shares, it indicates a negative sign that they are there to mint money & not bothered about the company.
9. High salary & relatives on the management team: This is NOT a deal breaker. If the management is working hard to grow the company, its fair for them to be compensated accordingly.
Please remember that it’s not an exhaustive list. I don’t think anyone can prepare such list. Keep your eyes open & apply your common sense and logic.
Please comment below in case of any query.