Friday, February 27, 2015

Judging the quality of management

Management is a big issue in value investing in India. From the US perspective Buffet is of the view that you don't need a great management to run a good business and a business with poor economics cannot be turned in a business with good economics with good management.

In India the control environment is not as great and thus investors are in the dark about how to judge management. My attempt here is to provide a framework checklist that can give you some cues into how to judge management.


  • Director Remuneration - Typically the whole direct set should not exceed lower of 1% of revenues or 10% of PBT. Higher numbers indicate that the management is more interested in getting compensated than driving up the value of the company.
    • I find that too low director remuneration can also be an issue unless the promoter is already a very rich person and is taking little salary.
  • History - if there is a history of delisting of securities one should tread carefully. A very wise investor once told me that the maximum amount of wealth is created when a management team after trying unscrupulous looking stunts comes back with a listed company and have tasted the salt of the market cap game.
  • Professional history - Professional history of each of the individuals also matters
  • Changes in auditors, CFO or legal council - can signal issues within the company.
  • Quality of audit firm - is highly important but given the history of Satyam computers case a brand name is not a perfect protection for investors.
  • Interest / other income from investments - If the investments or cash balances are not earning any income or are not clearly stated then it is a warning sign
  • High % of pledged shares - can mean the promoters have taken loans against the stock of the company. This per say is not a bad thing but can mean several linked things like over leveraging, betting more than they have, etc.
  • Cash flow from operations vs net income - if this is happening you need to be worried about overstated financials
  • Increasing working capital - If the working captial consumption is going out of control (Rising inventories, debtors )
  • Creditor balance - Too high a creditor balance can signal a callous attitude towards suppliers who are stakeholders in the sucess of the company like investors, lenders, customers and employees.
  • Low average employee compensation - This is a bad management scenario - and signals low quality of employees in the organization
  • Too much cash hoarding on balance sheet is a warning sign too - one needs to be careful of such situations.
  • Royalty payments to promoters is a warning sign as well
  • Investments in unrelated businesses are also highly bothersome
  • Focus on unlisted entity - while having a languishing listed entity is also a dangerous situation
  • If you decide to meet management BEWARE - they are excellent sales people and typically investors get mesmerized with management
There is a wonderful article by Ashish Kila (Perfect Research) on the role of management in long term investing that I highly recommend.