Check The Management Before Investing

If you have any doubts about the management then you always have the choice of selling your shares or not buying stocks of those companies at all.

An informative excerpt from Anirudh Rathore's Investing Decoded: Simple Path to Building A Portfolio in Millions.

Since I have been running a business in the hospitality industry I have come to realize that management, particularly good managers, make a big difference to the outcome of the company.

Most industries are highly competitive and sensible decision making can change the future prospects of the organization.

Steering my own business has given me wonderful exposure to starting, operating and growing a business.

Dealing in finer details and operational styles as well as clasping available opportunities is inherent to good management.

Setting up systems and processes, delegating work and having the awareness to expand the business is also of great importance.

The problem with publicly listed stocks is that you cannot go around meeting hundreds of managements -- it is just not practical.

I would suggest that for any common investor, the focus should be on the balance sheet and the profit and loss statements published by the organizations.

Companies have them available on their Web sites. So all you need is a good Internet connection.

The financial statements will tell you whether the stock is part of an industry with favourable economic characteristics.

If so, then even a medium-quality management will be able to deliver good results.

At times, in industries with poor economic characteristics (hotels, infrastructure), even excellent management cannot produce great results.

The products of these industries are top-class but the financial characteristics are below average.

Their return on capital metrics are usually below 10 per cent. You are not going to make much money on shares of such companies.

A good way to get a sense of where the managements are steering their companies is watching business channels.

Every day, from many industries, you have management giving short interviews regarding their future outlook for their corporations.

I think these are very helpful. A lot of management give lucid and reasonable projections for their organisations.

Another way to get a sense of the company's future prospects is by visiting the Web sites and playing the audio recording of the earnings call after every quarter.

Here, managements are put on the scanner by various analysts and investors, and you get a good sense of the direction the company is being taken into by the management.

A corollary of going through financial statements is that the managements should produce honest and true books of accounts.

A method which analysts use to keep a lookout for shoddy accounting is to see whether the auditor's fees is going up disproportionately to the company's revenues.

Such companies are usually red-flagged. Most companies with good accounting practices have clear and simple accounts.

A crucial difference that emerges between managements is regarding the capital allocation decisions made by them.

A lot of companies have shown that they have been unable to master this crucial and critical job.

If the management is inclined towards the interests of the shareholders, they will have to keep the return on equity as high as they can.

One of the biggest stumbling blocks for many companies is that the senior management may be very adept in sales, marketing and administration, but does not have the required experience to make good capital allocation decisions.

Paying too much for acquisitions can derail the future return ratios, if not managed carefully.

Also, using the cash that has been generated, if the management is unable to see business/investment opportunities, then they need to buy back or repurchase shares of their company.

Here too, the timing needs to be correct.

Warren Buffett wrote on share buybacks that Berkshire would only buy its stock 'If (a) Charlie and I believe that it is selling for less than it is worth and (b) The company upon completing the repurchase is left with ample cash.'

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Surprisingly, after the global COVID-19 crash, there were very few companies that announced any share buybacks.

The stock prices had collapsed and companies with strong balance sheets could have taken advantage of that situation.

Most of the share buybacks of 2020 have been announced at the recovered prices of the stocks, such as Tata Consultancy Service, Wipro, Ajanta Pharma, etc.

So a lot depends upon the crucial decision-making skills of the management.

If you have any doubts about the management then you always have the choice of selling your shares or not buying stocks of those companies at all.

A shining example of great management skills has been the HDFC group in India. They pioneered housing finance in India in 1977.

From there, they have created stellar organisations over the decades, such as HDFC Bank Limited, HDFC Standard Life Insurance Company Limited, HDFC ERGO General Insurance Company Limited, HDFC Asset Management Company Limited, GRUH Finance, HDFC Venture Capital Limited, HDFC RED and Credila Financial Services Private Limited.

All companies are run by motivated managements working towards growing shareholder wealth.

Quality managers can generate tremendous wealth for shareholders. Companies that are inclined towards growing shareholder value are the quality establishments that investors should remain on the lookout for.

Indian corporates have seen a tremendous shift in attitudes, and now siphoning off capital is being replaced by companies working towards improving market capitalization, which makes the future prospects look very encouraging for investors.

Excerpted from Investing Decoded: Simple Path to Building A Portfolio in Millions, by Anirudh Rathore, with the kind permission from the publishers Penguin Enterprise, a division of Penguin Random House India.

Feature Presentation: Aslam Hunani/Rediff.com