How To Find Quality Management?

Welcome back all of you. I hope you liked the previous articles which i wrote on different topics.

So let’s start with today’s topic.

I have already created video on this topic, you can check here.

In 2018 if you will check, highest number of auditors and independent directors resigned and after that stocks crashed 70-80-90%,like Manpasand, Vakrangee and many other stocks. We as small shareholders trust the auditors and when they resign without giving clear reasons what we should do ?

Research should start before buying the stock not after buying it :

You really can’t do much after auditor resignation and when stock crashes, actual research should start much before you decide to buy that stock. So what you should check to find the Quality management ?

This is my checklist to understand management :

1.Management Remuneration :

Management can get their Remuneration by 2 ways. One by holding stake in own business, so they can get benefited by stock appreciation as business develops and they can also get dividends according to dividend policy. Another way of getting remuneration is to take out salary. In India most of managements focus more on salary and less on developing business. There is a rule that ,management can take 10% salary of the company’s net profit for that year. E.g. If company have more than 1 director and net profit for the current financial year is 100 Cr so together they can take 10 Cr as salary. But i think if management is really interested to develop business then they should focus on business and not on salary. In FY 2019 some of the managers took salary as high as 120 Cr which was 40 Cr in 2018 and 2 Cr in 2017. So why sudden jump in it ? As their profits got increased due to some external factors and they took commission out of it as salary. It is according to  the rule but I generally avoid these high salary taking managements. If promoters hired professional management then we can consider bit higher salaries to keep talent in company but if owner itself is managing the business then he should focus more on business development.

2.Are they paying taxes ?

To check basic level of integrity we should check if company is paying enough taxes or not.If they are not loyal to government then mostly they will not take decisions which are shareholders friendly.In manpasand beverages case first auditors resigned without giving any reason and stock crashed from 500 Rs to 100 Rs and then when GST fraud broke out and it crashed further from 100 Rs to 10 Rs and destroyed huge wealth.

3.How are they treating the employees ?

Another level of integrity check is how management treating employees ? Are employees happy to work with organisation ? Are they paid enough ?What is the culture in organisation ? These are subjective questions and answers will depend on the particular individual, but we will get more insights of company by asking these questions.

4.Are they declaring dividends ?

This is the another check for management. If company is profitable then are they declaring dividends ?Dividend declaration depends on many things like companies debt position, growth target and growth capex. Ideally company should not announce any dividends as they have to pay dividend distribution tax and they can use that accumulated profits to grow the business.Berkshire hathway never paid any divided to shareholders,but in India things are not that transparent,managements are not clean and most of them don’t think of minority shareholders.So we should check what is the dividend payout ratio ? Is it enough ?  Where management using remaining profits ?

5.What is succession planning ? 

In India most of businesses are family driven,so succession planning is very important. What are the plans of management for 2nd generation, are they handling over to family members, if yes then is 2nd generation competent enough to manage the business or they hiring professional managements. These are serious questions one should ask before investing in any stock. Few of the best managements in india are TATA Group,Marico,Asian Paints,HDFC Group. 

6.Check performance of management when economy in slowdown

When economy is growing then every tom,dick and harry will do well, but we should judge actual talent of management when there is recession or slowdown in economy.As warren buffet said “Only when the tide goes out ,you discover who’s been swimming naked.” So we should check the performance of management,when economy is in slowdown.Is management taking correct decisions under pressure ?

7.Do they accept their mistakes ?

We are humans and mistakes do happen but do we accept our mistakes or we give reasons for them ? We should check if management accepting their mistakes,learning from it and then growing. In course of business, mistakes will happen but we should check management’s response to it.Many of them are not ready to accept mistakes and this shows character and can cause problems in long run. 

8.Short term or long term vision ?

We should check the vision of management, are the changing their business model for short term benefit? Is management focused on next quarter profit or they focusing on long term growth. Most of managements’s focus on immediate profits and then it affects the performance in long run.We should avoid such managements.

9.Over-commitment/Under delivery

This is another problem with growth oriented managements. They give high growth targets which are impossible to achieve and then finally end up delivering lower, we should stay away with such managements.Those who under-commit and over deliver on consistent basis are one of the best managements.

10.Diversification / Cash holding

Is management doing unnecessary diversification ? Focusing on core business always helps in long run,so we should check if management is entering in completely new sectors. We should also check how much cash they are holding and how long ? Because in liquid funds you won’t get more than 7-8% returns and if business able to generate 15-20% ROE(Return on Equity) then why are they holding cash and what are the reasons for it ?

11.Intelligence, Energy,Integrity

As warren buffet said “In looking for people to hire, you look for three qualities: integrity, intelligence, and energy . And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without [integrity], you really want them to be dumb and lazy.” So only competence and intelligence is of no use without integrity and in India Intelligence is in abundance but integrity is very low.

So these are the few factors we should check to find Quality Management to whom we can trust and sleep peacefully after investment. Let me know your experience with managements by commenting below. 

Don’t for get to watch video on this topic.