On Judging Management-Character:
- Strong Track record of Shareholder Friendliness (or a Self-Serving Bias): “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner but from their regard to their own interest,” said Adam Smith in The Wealth of Nations. The power of self-interest in business and economics is, of course, well established. Management character is best judged in the proxy statement – what do they pay themselves and how? Is their financial self-interest truly aligned with mine as a shareholder? Ask: “Would I want to become the second partner with this CEO in a 2-person partnership?”
- Strong Track record of Integrity (either of Honesty or Fraud): Never expect to make a good deal with a bad person. When a manager puts his hands in shareholders’ pockets once, he’s much more likely to do so again.
- Of Humility: I prefer a manager having “lots of steak and little sizzle.” Better yet one who believes “the steak IS its own sizzle”. If he has the first, why would he need the second?
- Of Conservatism: If we visit a fan manufacturer in Texas and the CEO meets us at the airport in his Lexus, spends five hours with us and then takes us to dine out to an expensive restaurant, that is suggestive of somebody who isn’t as prudent as we would like.
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Candid Communication: Transparent, admits mistakes. How management recognizes and communicates its mistakes is very revealing.
On Judging Management-Performance:
- Strong Track record of Achievement. Both Operational and Capital- Allocation. “You can usually pick out the empire builders simply by asking how they allocate capital – they tend to have a hard time zeroing in on a concrete answer.” – Warren E. Buffett
- A focus on the business, not the share price. “The first question I ask is: Does the owner love the business or does he/she love the money? It’s very easy to tell the difference.” – WEB
- Of Jockeys and Horses:
1. “Invest in a business that an idiot can run. Someday one will” – WEB.
2. “When a management team with a reputation for brilliance joins a business with poor fundamental economics, it is the reputation of the business that remains intact.” – WEB. Choosing a good jockey is important but choose a good horse first. The world’s greatest jockey on a nag is not going to win.
3. With Deep-Value plays, a competent management is sufficient. You need someone who won’t screw up the asset values. With Moat-plays, a first-rate management is vital. You need people possessing great capital allocation skills.
More On Judging Management-Performance:
A most important question for a shareholder and the board to ask any CEO is: “How do you measure the ways in which you are successful in running your business?”
Not surprisingly, we hear answers like:
- increase share price
- incorporate goals established in conjunction with the board
- accomplishments relating to customers and employees and the community and the shareholders
Few ever answer that they measure their success by the “growth in per-share economic value”. What then is “economic value” and how do we measure it? Look at the opening pages of a Berkshire Hathaway annual report, and what do we see? We see a record of “growth in (tangible) book value per share” for 40 years. 40 years! At Berkshire that number, is 20% a year for 40 years. Here is WEB on this point:
“Charlie and I measure our performance by the rate of gain in Berkshire’s per-share intrinsic business value. If our gain over time outstrips the performance of the S&P 500, we have earned our paychecks. If it doesn’t, we are overpaid at any price. We have no way to pinpoint intrinsic value. But we do have a useful, though considerably understated, proxy for it: per- share book value. This yardstick is meaningless at most companies. At Berkshire, however, book value very roughly tracks business values. That’s because the amount by which Berkshire’s intrinsic value exceeds book value does not swing wildly from year to year, though it increases in most years. Over time, the divergence will likely become ever more substantial in absolute terms, remaining reasonably steady, however, on a percentage basis as both the numerator and denominator of the business-value/book-value equation increase.” – BRK Letter to Shareholders, 2011
Growth in economic value per share then is the holy grail of judging the performance of any capitalistic enterprise. Intrinsic Value/share or Book-value/ share or Tangible BV/share may all possibly serve as useful proxies depending on the business.
– Husain Kothari
13th January, 2013
KIP Capital blog 