Clients should invest in financially stable businesses that have good management teams. But getting a handle on management is a difficult task when evaluating companies.
Start by reading the company’s annual reports. And then use these three tips to determine if there’s solid management in place.
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Candid communication
Good management will go beyond the minimum reporting requirements to shareholders. This means admitting mistakes and disclosing what course of action will be implemented to remedy the situation. The absence of such candour should be considered a red flag when choosing where to invest.
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Management for the long term
Running a good business requires management to have a long-term view. When reading annual reports, don’t stop at the most recent year. Going back in time will determine if there is a consistent operating history. Steer clear of management who appear to use an ad hoc strategy or concern themselves with quarterly results—they’re likely focused on managing numbers rather than business.
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Allocation of capital
Look for managers who act like owners. They won’t lose sight of their prime objective—to increase shareholder value.
And once a company generates more cash than it needs for development and operating costs, there are two choices: reinvest in the business or return the money to shareholders.
Both options may sound great, but it’s only wise for management to reinvest if they can produce a return above the average cost of capital. In fact, it would make sense to retain and reinvest all of the company’s earnings if this were the case.
Read more: Finding the right fit >