As a stock investor, one of the first things that you learn is that the secret to generating steady returns from the stock markets is buying high-quality stocks. That being said, there are numerous ways in which a stock can be analyzed for quality.
You can look at the financials of the company or how it fares with respect to its competition or conduct a business and industry analysis to assess its standing in the market.
While all these are important to get a comprehensive view of the stock, assessing management quality is undeniably one of the most underrated but critical aspects of stock analysis.
As an investor or someone who is planning to stay invested for the long-term, it is important to consider the shares purchased for what they are – a shareholding in the company.
Hence, if the company does well, then the shareholder profits too. Apart from the external market and economic forces, the management of the company plays an integral role in its success.
Since retail investors do not hold a huge portion of the company’s shares, they cannot influence the decisions made by the company. And so, they would have to depend on the decision-making ability of the management team.
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Something to think about
Let’s say that you are considering buying shares of a company that has promising financials. Also, it has a competitive edge in some products and has an appropriate valuation.
While everything seems good on the surface, when you start looking at the management of the company, you realize that a couple of promoters are selling their shares rampantly.
While there can be many reasons behind this, one possibility is that the company might be conducting fraudulent activities and the promoters are trying to sell their shares before the fraud is exposed.
There are also times when the promoters of the company siphon away money using subsidiaries. To ensure that the management of the company does not destroy the wealth generated by the business – knowingly or unknowingly, it is important to conduct a management analysis of the company before buying the stock.
Here are some tips to help you:
1. Check Backgrounds of All Promoters
The track record of the company and its promoters can shed light on whether the shareholder’s interests are prioritized or not. A simple Google search is usually enough to understand this aspect.
If you find any hint of the promoters playing funny with the investor’s money, then you might want to reconsider your decision of investing in the company. Most importantly, check if the company has any regulatory issues with the authorities like SEBI, RBI, etc.
If there is enough suspicion, then ensure that you research further before deciding to invest.
2. Remuneration of the Senior Management Personnel
This is another important aspect of assessing the management quality of the company. A company offers remuneration to its key personnel in different ways like salary, allowances, perquisites, etc.
If the company is increasing the pay of its management disproportionately to its profits, then it could be bad for the company. Hence, it is important to ensure that you go through the data on the remuneration of the management available in the company’s Annual Report.
Study the year-on-year increase in salaries as compared with the profits.
3. Related Party Transaction
While assessing the management of a company, ensure that you don’t miss looking at the Related Party Transaction section of the annual report. This section will give you an idea about all the transactions that the company has had with entities associated with the promoters or their relatives or joint ventures.
Many promoters attempting fraud use this route to siphon money from the company. Hence, it is important to study the Related Party transaction section carefully before investing.
4. Management Forecast
The annual report of a company also carries the plans regarding the future of the business. You can look for these details under the headings ‘Director’s Report’ or ‘Management Speak’ or some similar terms.
They are also usually present on the website of the company. Going through these details helps in evaluating the company’s management team’s strategy with respect to how it sees the business grow in the near and long-terms.
Compare the projections made in the past and assess the extent to which the management achieved them. Also, keep an eye out for any strategic changes introduced in recent years.
5. Dividend Payments
Most investors prefer dividend-paying stock as it ensures regular income. There is a general belief that shares of companies that pay good dividends are good investment avenues.
However, before making that decision, it is important to analyze the source of money for the dividend. While the logical assumption is profits, you will be surprised to see some companies distributing dividends from borrowed funds.
If it is the latter, then it highlights a concern for an investor. If possible, analyze the reason behind such a move. Else, steer clear of such stocks.
6. Manipulations in Accounts
Sometimes, management teams of certain companies try to create a different image of the company by manipulating the accounts and painting a rosy picture. They inflate the numbers making it difficult for investors to understand any manipulations. While you can hire a professional to get the accounts checked, even if you find the slightest hint of manipulation, avoid investing.
7. How Much Stake do Promoters Have in the Business?
If the promoter of a company doesn’t have faith in its business, then should an investor trust it? Usually, investors are comfortable if the promoter holds around 50 percent or more stake in the company.
This is not a rule though. A company that has a constant increase in the promoter’s shareholding is also a positive sign. On the other hand, a decreasing shareholding by a promoter over an extended period should be a cause of an alarm.
Assessing company management quality requires some time and effort. However, don’t skip this part as it is an essential aspect of the fundamental analysis of the company. Follow the tips mentioned above and ensure that you analyze the management quality of the company thoroughly before buying.
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