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The Importance of Management
by WealthEffect Staff

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Management must have the ability to make the most of a company's opportunities
 
  Managers must be worthy of both your trust and your money  
  Exceptional companies led by quality managers will usually produce investment winners  
 
1.

Finding a company with a sustainable competitive advantage is the first and most important step. Next, and nearly as important, is determining the quality of management. Your goal is a management team that is both "great" and "good".

A great management is one with the ability and the desire to realize a company's potential, much like expert card players make the most of the hands they're dealt. Great managers recognize the power of competitive advantage, and are fanatics in protecting and even improving their advantages. They understand the importance of effective capital allocation — namely, how they should be spending the company's money.

 
 
2.

Managers should also be worthy of the trust you give them when you invest in their company. They should be honest and fair with their shareholders who, as the owners of the company, are their bosses. If you owned a small business, you would expect this of the people you hired — why shouldn't you expect the same in a large business?

Since the priorities of a company are usually set by the chief executive officer (CEO), it makes sense to look at the priorities of the CEO. One approach is to examine how the CEO is paid, which is disclosed each year in the company's proxy statement. You would like to see the CEO have the opportunity to become rich by making the shareholders rich. This can be done through a generous bonus plan based on achieving well-defined results.

Stock ownership by the CEO is important, as well, but that ownership should not be as a consequence of large and recurring gifts of company options. Such options have no downside to the CEO and diminish the upside for you and the other stockholders.

The annual report provides another glimpse into the thinking of a company's CEO. Read the letter to shareholders at the beginning of the report. Get a sense of whether the CEO is concerned about telling you what needs to be done and how to do it, or is content to toss out "warm and fuzzies" about hard work and good people.

You should also take advantage of opportunities to meet senior management. You might not be very comfortable analyzing a company's cash flow statement, but you're probably pretty good at sizing up people — after all, you've been doing it your entire life. Even if you own just 1 share of stock, you are entitled to attend a company's annual meeting, usually held in the spring. In addition, the Investor Relations Department might allow you to listen in on a company's quarterly updates, which are done by phone and often include top management. Increasingly, rebroadcasts of these updates are available by phone or Internet — ask the company.

 
 
3.

You should invest only in companies with sustainable competitive advantages and first-rate managers. Given the shortage of each, it might seem virtually impossible to find potential investments that have both. But there's a positive side to the problem. Exceptional companies attract exceptional managers and people of unusual skill gravitate to places of unusual opportunity.

Suggestion: Go to The P/E