The management of a company is in charge of meeting all the company objectives and ensuring that shareholders get due returns for their investments. It has the authority to make strategic decisions with the view to increase the profitability of the company and is therefore answerable to the shareholders and investors at large. However, if the management is incompetent, the company may not be able to survive in the long run let alone be profitable. Therefore, as part of assessing a company for investment, management assessment cannot be missed.
Given below are the ways to assess management quality and competence for effective analysis of a company.
Why is it important to assess the management of a company?
A company and its owners are two distinct identities in the eyes of the law. While the shareholders are the actual owners of the company, they are not permitted to interfere in its day-to-day affairs. This is the responsibility of the company’s management as well as to ensure that they take strategic decisions that benefit the company and ultimately the shareholders. If the management of the company does not act in the best interest of the company or has vested interests, such companies eventually lose out to competition or fade away due to their unhealthy practices. Therefore, it is rightly said that the management of a company is like the captain of a ship. When a ship is not navigated correctly through turbulent waters, it won’t take long to sink.
How to do a management analysis of a company?
One of the top billionaires of the world Mr. Warren Buffett said that management can be judged on two accounts, namely, how they run their business and how efficiently they allocate the capital to achieve company objectives. Some of the key parameters that can be used to assess management quality are mentioned hereunder.
- Check promoters background
The starting point for assessing management quality can be looking at the promoters’ backgrounds. Their past companies or ventures handled by them, their educational qualifications, and the work culture in the company are a good reflection of the company’s management and its caliber. Analysts can also assess at least 5 to 10 years of the company’s past performance to ascertain if the management has been successful in providing stable and efficient leadership to the company.
- Check the management remuneration
An important point of reference is how much remuneration the top management is taking for themselves and the percentage increase in the event of profits or losses in any year. If the management is awarding themselves salaries in excess of the percentage increase in profits, it can be considered detrimental to the interest of the company.
Another point of reference can be comparing the remuneration of the management to that of other companies or the industry standards. This will further help in understanding if the management remuneration is in sync with the company’s performance or is out of the ordinary.
- Check if the capital allocation is optimum
Capital allocation is one of the key parameters to ascertain a company’s profitability. It is one of the most crucial tasks of the management to allocate its available resources efficiently so as to increase overall profitability. An important yardstick to measure the optimum allocation of capital is reviewing its ROCE (Return on Capital Employed). A company where the ROCE is at par with the industry standard or is more than the same is a reasonable assurance that the capital of the company is employed efficiently.
- Assess the financial statements for consecutive years
The financial statements of a company are the true assessment of its performance. By comparing the financial statements of consecutive years, one can analyze if the company is on a growth trajectory or otherwise. This can further be used in analyzing the management decisions and the strategies adopted during the course of business and their ultimate impact on the bottom line of the company.
- Management forecast for growth and expansion
The financial statements of the company also have the section ‘Director’s Report’. Under this section, the management lays out its vision for the company and future projections based on careful analysis. This forecast can give the investors and lenders a fair idea of what to expect from the company in the future and their long-term goals which can include expansion of business, diversification of the business, etc.
- Transparency and communication throughout the organization
An organization where there is transparency in operations and clear communication throughout the company will instill higher confidence among investors and lenders. The management integrity and ethics that trickle down the organization is what shape it and ensure that the company as a whole function using best business practices.
- Minority representation and treatment of management towards minorities
The true attitude of the management of a company can be interpreted by analyzing the minority shareholders’ representation in the Board of Directors as well as their treatment. The company management should be working in favour of all the shareholders which include the minority shareholders too. If a company does not work in their interest or if they are often unheard, it can lead to disgruntled shareholders and may feel like the oppression of the minority class. Such situations are bad news for the company and can have an adverse impact on its stock prices.
- Management representation in the audit report
The auditors of the company are responsible to ascertain if the company’s financial records show the true and fair view of the company. In the process to do so, auditors often seek management representation in matters where they may not find enough evidence or supporting documents to form an opinion. When such management representation is in plenty in the audit report it can be interpreted as warning bells as the management does not have sufficient backing for its decisions or for questionable accounting treatment in some cases.
- Related party transactions
In every annual report, there is a section ‘Related Party Transactions’ which provides information relating to any transactions done by the company. Under this section, details relating to the transactions with related parties like promoter entities, entities held by their relatives, transactions with subsidiaries, etc are given. This section therefore should be studied in detail to ascertain that the company is not window-dressing the books of accounts or favoring such entities over competent ones.
Assessing management quality is one of the important aspects of the fundamental analysis of a company. However, most investors, especially novice investors, fail to undertake this crucial step while picking stocks for investment. It is also important to understand that while other aspects of fundamental analysis are quite clear in computation like ratio analysis, assessing management quality is quite subjective. Therefore, analyzing the management quality can be tricky but is no less important in getting a fair idea of the affairs of a company.
The other aspects that can be reviewed while analyzing a company’s management are the tenure of management, management’s decision in declaring dividends, management stake in the company, debt-equity ratio of the company, etc.
A few basic criteria for evaluating management competence can be the performance of the company over the years, the relative position of the company in the industry, the demand for stocks in the market, comparison of financial statements of peers, and analyzing their cost of operations, etc.
Auditors of the company are the external evaluators that have the responsibility toward shareholders to give their opinion on the company’s financials. If the auditors are not able to complete their engagement or cannot provide a reasonable assurance in their audit reports, the same can be interpreted as errors or serious offenses on part of the management upon further analysis.
The key areas for a company that a management report should include are management goals, strategies, forecasts, and reasonable expectations in the face of changing dynamics of the business.