The starting point in identifying a good long term investment begins with screening companies on the management filter. This is an intangible that is subjective and hence the perception could vary among different investors. It is very important to be in the right company, especially if you are a long term investor. After all you are known by the company that you keep!!
So how does one judge managements? It is hard to find a fixed formula for doing so, but, the below mentioned check-list, could assuage the issue fair bit:
First, start with checking on the promoter stake. A high promoter stake indicates strong interest of the promoter, in the company
Second, it is important to check if the promoter stake is pledged. If a large part of the stake is pledged, that’s a red flag. It gets even worse if the pledge is done to fund a new venture solely owned by the promoters
Third, check for related party transactions. Several promoters/managements promote companies that are 100% owned by them. These companies act as vendors/customers for the listed entity. These transactions could be conduits to transfer profits to these fully owned entities. Any loans given to promoters or their other ventures also merits attention
Fourth, optimum allocation of capital has been an issue for several shareholders. Companies may be allocating capital to low return generating businesses/assets. While such allocations dilute the return ratios, such moves may also lead to unnecessary diversifications
Fifth, a comparison of the remuneration of the promoters with other employees of the company, could reveal the attitude of the management towards it’s employees. A large gap between the remuneration of the promoters and rest of the employees, indicates centralized command and inadequate professionalism. It also indicates an indifferent attitude towards employees. Such discrimination in most cases ends up in a high employee churn
Sixth, regular dividend payouts indicate genuineness of cash flows and the shareholder friendly nature of the management. Good companies usually have a transparent dividend payout policy
Seventh, check for a history of capital expenditures done. Several companies especially in the asset intensive businesses, incur needless capital expenditures.. The project costs are inflated. Such expenditures could be conduits to siphon off funds from the company
Eighth, check the working capital requirements. The credits given and taken, give a feel of the management’s attitude towards customers and vendors. A comparison with competition gives out the abnormalities
Ninth, contents and language of the annual report reveal a lot. Managements that are specific and frank on their performance and outlook, tend to be well received by the investors. The annual reports need to be detailed enough to give the shareholders, who are also part owners of the company, a good glimpse of where the company is headed. A careful scrutiny of notes to accounts could reveal several contingent issues that the company may be facing
Tenth, it would be worthwhile to check the interactions of the promoters/managements with media and analysts. A careful analysis of such interactions gives out subtle details of the character/attitude of the promoters/management
Eleventh, companies having numerous subsidiaries or joint ventures, without adequate rationale, may not be above aboard
Twelfth, it is important to check the Board of Directors. The more independent and qualified the Board, the better it is for governance. Several managements stuff the Board, with family members/friends making the company almost family owned
Thirteenth, the kind of banks that the company deals with too gives some glimpse about the character of the management. There have been several instances of fraud/cheating by the top management in collusion with their bankers. Companies dealing with banks of size and repute, do lend comfort
Fourteenth, the same applies with auditors. Auditors who do their duty as is meant to be done, without fear of losing their customer, ensure that the financial statements present a true and fair picture
Fifteenth and perhaps among the key filters is the growth trajectory and the vision. Investors would do well to check the past growth track record and the clarity of the management on it’s plans for the future. Good managements spell them out clearly.
While this checklist is not full proof but should be good enough to weed out a large part of the unworthy companies from the investible universe. As investors gain more sophistication, several other filters could be added to further fine tune the search.
Do send us your feedback, on the article to enable us to improve further.
Enjoy investing!!
Disclaimer
This article has been written by Team Capital Portfolio Advisors, under the guidance of Mr. Paras Adenwala, Founder, who is registered with SEBI as an Investment Advisor.
Any part of the content of this article should not be construed as, an offer or solicitation to buy or sell any securities or make any investments. The content shall not to be relied upon as advisory or authoritative or taken in substitution for the exercise of due diligence and judgement by any user nor should it be used as a basis for making any decisions, without exercising user’s own judgment or diligence. As a condition for using this Blog, the user agrees that Capital Portfolio Advisor (CPA), its Founder or any of it’s employees make no representation and shall have no liability in any way arising to them or any other entity for any loss or damage, direct or indirect, arising from the use of the Blog. CPA reserves the right to change the content of the Blog without prior notice.
Very well articulated. But I was just wondering how could any normal investor could have assessed YES BANK or Franklin Templeton mutual funds . Could you please provide specific pointers .
Thank you very much for your feedback. Appreciate!
The writing was on the wall, for Yes Bank. Most well managed banks grow at a clip that is around 2x the GDP growth rate. Yes Bank grew at a rate significantly higher than this rate, consistently. That was a red flag! This could have been achieved only by assuming risks that were unnecessary. Managing risk is more important than managing growth, in a lending business. Lending needs conservative managements!
As far as Templeton debt funds are concerned, it would have been hard for a common investor to imagine the problem. To be able to do so, their portfolios and the returns need to be monitored actively. We were fortunate to have been able to exit from their funds, in time, since, we have known the investment style of the portfolio manager. It was not in synch with a slowing economy!