Investing Forum - Warren Buffett and Value Investing
Intrinsic Value Questions
Management Based on Long Term Goals - how to determine?
Intrinsic Value Questions
Stig & Preston's "Warren Buffett Accounting Book" Principle 1 Rule 4 states that management must be incentivised on long term goals.
Just wondering what metrics (e.g. stock options) you would need to see to qualify?
edited January 16
I am not sure about others but for myself I look at leverage, things like Debt to Equity ratio and particularly the quick ratio. On occasion with more regular income streams management can have a quick ratio below 1 but usually you want this above 1 or 1.5 as a minimum.
You can look at ROE or operating margins to look at the competence of management to generate bottom line revenue. Some industries are very resource intensive like mining, others are very R&D dependent like pharma and some tech so you may see lower numbers in ROE and operating margin even though they keep paying dividends. Usually these companies are reliant on revenue growth. The higher the operating margin and ROE the higher the degree of safety and the ability to generate increased shareholder wealth.
Share buy backs shows management confidence and commitment to grow shareholders revenue especially when the share price is at a low p/e. If they buy shares back when the price is at a very high multiple this is a sign of poor management or at least a lack of suitable use of capital. If management feels it has no better opportunity cost they should return some of the capital to shareholders through dividends.
I own FF future Fuel stock which is a very well managed company with low debt. They have increased earnings even with declining revenue and have a ton of cash sitting on the books so they just declared a 16.5% special dividend on top of their regular dividend as it is a chemical plant and the business can only utilize so much cash. Management therefore announced a special dividend to return the capital to shareholders.
Looking at the statement of cash flow, the operating expenses on the income statement or the debt and equity sections of the balance sheet are also good place to see how management is utilizing funds. Often you may notice certain things that look out of place. If you are looking at something on the financial statements that is confusing then this is often a warning sign. Like Buffet says invest in companies you understand.
Another thing is income is supposed to vary to some degree. I heard recently from Tobias Carlisle that if earnings looks too consistent it can be a sign that management is manipulating the numbers. That is why Tobias uses EBITD for his calculations as the further down the income statement you go the easier it is for management to manipulate the numbers.
You can look at the annual and quarterly fillings for notes about accounting methods if they use GAAP of non GAAP measures for certain things or if they use the IFRS standards. Management can choose the accounting policies so the notes can contain a lot of key details. Here they may contain bits about management compensation too as it may affect the financials.
Lastly take a look at the corporations website. Most medium and large corporations will have management's photo's and bio's on the site or at least the companies mission and corporate responsibility. Read this information especially if you are unsure about the company. Look particularly at the CEO, CFO and possibly the COO if they have one. These guys set the tone fore the whole business.
I am sure there are other ways to check as well, you can even look on glassdoor and things as well to try and get an inside look at management style.
This is a pretty thorough approach, I am sure other people may have more suggestions. As you start to look through the valuations, financials, and companies website you should be able to get a good idea in a fairly quick amount of time.
Thanks for that Ghazel - very good insights here.
It is quite complicated as you've said but I think trying to work out how mgmt will grow the business long term is not just a matter of a simple ratio....
In particular, your thoughts on the 10K / 10Q reports are a very good way to determine just what the compensation structure.
I've been looking at the 10K and Proxy for Netflix, but can't see any bonus or incentive based on anything other than quarterly results / targets (I may be reading this incorrectly!?)