A company is only as good as its people. And that is reflected in the management analysis of a company. More often than not, the way a company is led into the future affects its performance as well as its profits. Similar to how studying the financial performance of a company is vital to understanding its future, so is its management analysis.
The Purpose Of Management
When you’re investing in a publicly listed company, understanding the management helps you get insights into how it’ll fare in the near future. The stock price alone cannot reflect the quality of management, as seen in companies like Satyam Computers.
Efficient management is one of the pillars of success for any company. Employees are also key to its performance, but management makes all the decisions that strategize the company for the future.
Their vision is brought to life through employees and how successful they are, is directly reflected in the income statements. Quite simply, think of a company as a vehicle, and the top management is the driver behind the wheel.
No matter how advanced the car is, it’s ultimately the driver’s responsibility to operate the vehicle well. Before diving into learning more about the management analysis of a company, you need to understand that it is more of a qualitative study.
Importance Of Good Quality Management
Most retail investors like ourselves study a company from a financial point of view – studying ratios such as Price To Earnings and sales growth. Naturally, most new investors turn a blind eye to studying its management. What they don’t realize is that their investment is dependent on how the board drives the company into the future.
Making things more difficult is the fact that studying a company’s management is not the same as going through balance sheets and income statements. In fact, there is no fixed approach to judging top management. There are a few ways to understand where the company is headed.
1. Promoters
The promoters of the company are the founding members who were involved before taking it public. Generally, they hold a majority stake in the company. Under this section, we must take a look at several factors surrounding said promoters. They are –
- Promoter Holdings
- Background
- Tenure
- Salary
- Promoter Holdings
The holdings of the promoters represent how much of the company is owned by them. Generally, promoters who hold a majority stake in their company are a positive sign – It means that they believe in the company and its future prospects, so they wish to hold onto their stake.
A negative sign would be consistent selling of stakes and low promoter holdings. When the promoters themselves have trimmed their holdings in the company, then it is usually represented as a bad sign. However, in some circumstances, promoters tend to sell their holdings to raise more capital as well.
- Promoter Background
Promoter’s background check helps assess their capacity to take the company to the next level. This can be studied by knowing their experience, other associations, previous projects, and the overall culture of the company.
A quick search online or through the use of a stock screener platform can reveal the promoter’s background, including previous business experience, known affiliations, and an overall track record.
Promoters can create a company culture as per their management style. It could be flexible and open to change or rigid and conservative. Either way, it affects the way employees perform within the company, along with its reputation in the industry.
As a thumb rule, management with good experience and successful projects is better.
- Tenure
Here, tenure could be interpreted in two ways –
- The overall experience of management and,
- The duration of tenure at the company.
Leadership roles require a certain level of experience, which give the company a better advantage over its competitors. This advantage is directly seen in the company’s historical performance data.
- Salary
Promoters as well as top-level management usually reward themselves with performance-based incentives and salaries. It’s important to understand why salaries should be studied.
If a company is having bad years where it is making losses consistently yet the management is paying themselves high salaries, then it is advisable to proceed with caution.
Salaries cannot specifically be compared and estimated to be high or low but taking a look at the industry overview would give a general idea.
2. Capital Allocation
As discussed above, the management of the company makes key strategic decisions. These decisions have a direct impact on the company.
Capital allocation is when a company invests the excess cash generated by the business. This is where the ROCE (Return On Capital Employed) factor comes into the picture. ROCE tells you how well the company is managing its capital in generating returns to shareholders.
3. Company Transactions With Third Parties
Promoters have complete access to the company’s capital, and they are free to use these funds however they feel right. Herein lies the issue where promoters have been known to siphon off funds for personal purposes.
In sections of the annual report, you can observe the transactions conducted by the company with outside parties. Optimistically, the transactions could be business related. Some of the key transactions to look for are –
- Transaction between promoters and the company
- Buy/Sell Transactions between the company and promoter/promoter’s entity.
- Funding Other Ventures.
4. Acquisitions And Investments
If a company is doing quite well, it may decide to acquire other businesses. From a strategic point of view, this is suitable in the long run, instead of competing with smaller companies. This is seen with companies in relevant businesses. For example – The acquisition of BlinkIt by Zomato.
In other situations, it may invest in other companies as a stakeholder.
The focus should be on the fact that the company is not deviating from its primary business.
5. Debt Obligations
When looking at the debt position of the company, one must keep two terms in mind – Management and Debt.
Good management knows how to restructure debt, run the company, and create shareholder wealth. Bad management is letting debt pile up and sinks the company altogether. High leverage is a red flag, as it suggests that the company has taken on huge amounts of debt.
In the long term, they will end up paying high amounts of interest on debt and that could potentially hinder growth.
6. Stock Buyback
Companies sometimes buy back the company shares in the market, which is taken as a positive sign. It implies that the promoters are aware of information that is not available to the public.
This increases the value for the shareholders, as –
- The company has some future goals that are not yet made public, and
- There are fewer shares in the market for potential investors.
7. Strategy And Goals
Every company has a vision for the future. Going through the investors’ report and statements, you will come across statements from the CEO and board of directors regarding where they plan to take the company, be it into new industries or tackling competition from rival companies.
This is also evident from the investments made by the company into new ventures and proprietary assets such as patents, trademarks, and copyrights.
While this information is not always publicly available, you can study the annual reports to get a better understanding of the goals that management has for the company.
8. Compensation
The fact that directors and CEOs make the big bucks in the company is no trade secret. In fact, their salaries are made public through income statements. And their pay is justified when you take into account the scale at which they have grown the profits of the company during their tenure.
In the compensation section, you must look out for the breakdown of their package. Usually, if they hold a stake in the company, then they are more likely to perform better as it directly benefits them, and in effect the company and its shareholders.
Another important factor to consider is every industry pays differently to its management. For example, the IT industry in India is one of the most rewarding industries, with packages going all the way up to 71 crores (Infosys CEO Salil Parekh, FY 2021-22).
So if you’re studying a company’s management, make sure that their compensation is similar to that of the industry.
Also Read: Techniques Of Financial Statement Analysis – Do It Yourself!
Takeaway
Management analysis of a company is not dependent on any one factor. Looking back at the success stories of major companies, it shows how management has played an important role in turning the tide.
Reading the income statement and quarterly reports alone does not tell the full story.
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