Tuesday, March 24, 2015

Getting conviction: Management quality factors

High conviction positions are the holy grail of portfolio management. The basics of this judgement have been covered in the judging the quality of management chapter in the principles section. Management matters a lot but not as much as business quality. Typically it is the most important factor after the business quality in the world of portfolio management. The idea here is the focus on the factors that need to be graded. I have to thank the Valuepickr forum and its contributors (especially Donald Francis) for helping me with this thinking. Typically I would give equal weight age to each of these 6 factors.


1.    Track record of honesty & execution – this is a tough one to judge as honesty is not always apparent in the financial statements. My approach would be to read everything that there is about the company and if you cannot find a thing about dishonesty then maybe some points should be awarded in this space. This can be seen by announcements versus action, ability to deliver what is promised, executing and delivering industry leading financials and branding. A portfolio manager with greater experience can start spotting these trends rapidly even during the process of reading the annual reports.

2.    Remuneration, education & experience – as a rule of thumb if the management compensation is over 10% of profit before tax for small companies and 5% of profit before tax for large companies I would stay away. Fairly compensated management teams are likely to do a good job. Even though I have no data to prove this but I believe well educated management teams with good global exposure are more likely to produce good & ethical results as well.

3.    Growth mind set – Growth is essential to the Buffet method of value investing. If the management team is lazy or not focussed on growth it will not happen on its own. This is apparent in the capital deployment into projects, timely investments in capacity addition with clear strategy, brand building initiatives, forward integration, backward integration, lateral opportunities.

4.    Special DNA that is hard to dislodge – You want a management team that is not going to give up in hard times – and ALL businesses go through hard times.
5.    Focus and self-confidence – Focus on the business at hand and not spreading too thin is also important in small and large companies alike. Leadership position in the industry should be apparent in either quality, quantity, technology, cost, or all of the above.

6.    Audit, pledging, dividend focus and small investor focus – Quality of audit firm is also important. This does not mean that a company with a big 4 auditor will not have ethical issues – but if there is some very small audit firm with no reputation auditing a massive company you know that something might be amiss.

a.    Dividends: Overall I have seen many astute investors say that companies with a history of dividend payments do well in the long run. Dividends are good because they compensate the shareholders in cash which shows a shareholder focus on the part of the board and the management. Too high a percentage of dividend payment would mean that the company does not have enough avenues to deploy the capital, but is good as they company has the sense to not waste the capital.


b.    Small investor focus – companies that have good reporting standards, very independent directors, and professional management teams typically will keep the interests of the small investors in mind. This in turn keeps up their brand in the investing community which in turn leads to higher valuations.

Value based portfolio management dictates that you make sure you research management through and through as even a good business with a dishonest management may produce not so great results or even horrible results.