Stock Shastra #10: Look for a trustworthy management, that respects the interests of minority shareholders

A short flashback: In Stock Shastra #2 we stated the 3 important characteristics essential to shortlist a wonderful company. The first two i.e. Excellent Financial Track Record & Sustainable Competitive Advantage were elaborately discussed in Stock Shastra #3 & #4. Now, coming to the 3rd characteristic; Respectable Management. You need to be sure about the people in charge, i.e. the management of the company.

So, why bother about the management?

Consider this: A company XYZ Ltd. has performed robustly in all its financials over the last few years, has grown its sales ten times and has also grown its EPS at an impressive rate. Also, it has a sustainable competitive advantage that guarantees a future winner. And, how can we forget to mention.. It is currently undervalued, too! So, how tempted are you to invest in this company? Very!!! You’ll probably be tempted enough to put in a big chunk of your savings here….

But, stop!  There’s a small catch here. It has a management which is infamous for a variety of things;  giving false information, arrogance with minority shareholders, known for insider-trading, or paying too much to themselves. Now, think again. Even though, this company may have the capacity to perform and be a winner in future, it has a management that you probably cannot trust to take care of your money. Now, is this the management you would want to stay invested with? Most likely no. You need to stay invested with a management who is trustworthy and respects your interests.

So, how do you check whether the management is trustworthy and respects the interests of minority shareholders?

With no model or framework to differentiate a good one from a bad one, it becomes difficult to judge management. But certainly there are a few clues/signs/factors that can guide you to assess the worthiness of a management and decide whether this is the kind of management you want to stay invested with:

1) Alligned with your interests: Check whether the managements’ interests are aligned with the interests of the shareholders

For this, check for the following clues:

  • Vision and plan : Does the management share a vision that appeals to you and a plan to implement it?
  • Compensation of top management: Is the compensation they pay to themselves reasonable enough? If the management is paying obscene amounts of money to themselves even when the company’s profits suffer, it is better to stay away from such a management.
  • Reducing interest in the company: Is the promoters interest in the company reducing? For this, check whether –

a) the promoters are reducing their stake holding often

b) the CEO and top management are selling/exercising their stock options periodically

c) promoters are pledging their shares;

If promoters are indulging in any of the above (a, b or c) , obviously they have their short-term interests vested with the company. Hence it is better to stay away from such a  management.

  • Buy-Back of shares: If the company buys back its shares at a time when the market is undervaluing its stock-price, it usually reflects the management’s confidence in the growth of the company

2) Qualified: Check whether the CEO is qualified to run the company or no? Does he understand the business well-enough to be able to run it well.

3) Transparency: Does the management share the actual threats, concerns the company is facing? If no, this is not the kind of management you should trust your money with. Also, does the management accept that it made a mistake − managements can make mistakes, but a good management is one who admits that it did.

4) Dividend payment in case the management is not able to increase its ROE further: Logically, the company’s net profit should be distributed among shareholders, i.e. the owners of the company, in the form of dividend. But, generally, the company retains a part or the entire profit and re-invests it in the company. What does a good management prefer – paying dividend or retaining the profit? A good manager retains a part of /entire profit only when he thinks he is able to earn a handsome return on it, otherwise he prefers paying dividend.

If there’s one source that can help you with the above points, it is the company’s  annual report; especially the Directors Report, Chairman’s speech & Management Discussion and Analysis

In a nutshell, we are looking for a leader who lives and breathes his company; someone we can trust our hard-earned income with, someone who can call a spade as spade.

So, which Indian management can you look at, as a benchmark?

If you want to have a good benchmark for management look at Infosys. Narayan Murthy (Chairman & Chief Mentor of Infosys) is not only known as the founder of the biggest IT empire in India (read Company Shastra on Infosys), but he is also known for his simplicity. He started with an idea, a vision and pursued it till it became a reality. The management of Infosys has been transparent in its operations and you will find them being very candid about the threats and concerns in management interviews/news items/ annual report. They also disclose the management remuneration in their annual report.

Another great leader is Ratan Tata (Chairman of Tata Group) – one of the most respected business leaders in the world. With his vision and leadership style he has made TATA group one of the leading conglomerates in the world. The Tata group operates on core values of leadership with trust. In fact, Tata Group has emerged as the most trustworthy Indian company on financial reporting in a poll conducted among domestic investors.

See you next week with Stock Shastra #11, where will tell you how to arrive at valuations for a company.

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15 Responses to “Stock Shastra #10: Look for a trustworthy management, that respects the interests of minority shareholders”

  1. Abhishek Narain 08. Jul, 2010 at 6:13 am

    You guys are doing a great job. Very well-researched articles and company analysis. Its just amazing. You have saved much time of investors who had to research themselves. Hats off to you!!..Please keep doing the great work.

  2. Team_MoneyWorks4me 08. Jul, 2010 at 11:34 am

    Thanks a lot for your appreciation.

  3. Kailash Thakur 08. Jul, 2010 at 2:43 pm

    stock-shastra really a very commendable piece of economic critical analysis of company &
    shares,it will certainly serve the cause to protect the interest of minority investors while choosing companies to invest money.
    thanks & regards.
    kailash thakur

  4. Your articles are good. It would be advantageous for the readers if you could name some 5 companies which meets the criteria which you were discussing.

  5. george mathew 19. Oct, 2012 at 1:29 pm

    Thanks for this useful lesson.

  6. proven that Reliance is not trustworthy

  7. Yes, reliance is not trust worthy. Because of this reason and also in 2009 i invested 30000 in Reliance infrastructure mutual fund listed at that time. after 3 years i got 24000 only. so i lost 6000. Lots people lost their money in reliance shares. so it proves that its not trusted company. Off course as you suggest TATA is really good. If i would have invested this 30000 in TATA, i could get 30% return on it.
    So, moneyworks4me team is it right for reliance??

  8. Virgil Williams 09. Jun, 2016 at 2:02 am

    Your method of a analysing a ompany management is very helpful.
    Thank you
    Virgil williams


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