Who's at the Helm? 10 Steps for Evaluating Management
By considering management's record and looking at the context of its decisions, you'll gain insight into whether a company is a good investment choice.
By considering management's record and looking at the context of its decisions, you'll gain insight into whether a company is a good investment choice.
Most investment research focuses on the quality of a business' operations, competitive position, returns on equity, earnings growth, and so on--and rightly so--but far less attention is paid to the quality of the people running the business. Both factors matter. Indeed, Warren Buffett frequently speaks about the importance of evaluating the people who run the businesses he owns.
Here are just a few examples:
While management itself cannot constitute an economic moat, at Morningstar we believe management’s capital-allocation decisions can lead to the establishment, enhancement, or erosion of an economic moat. Put another way, we want to better understand the intersection of management and moat with each company we research.
Our stewardship methodology emphasizes management’s record on items such as financial leverage, investment strategy and valuation, and operational execution, among others. We find these factors not only to be universally applicable for comparing stewardship across global markets, but also to better reveal how well management teams are allocating shareholder capital to enhance or establish an economic moat.
We're also keen to evaluate how well a management team has played the hand it's been dealt. Rather than using hindsight as our primary guide in evaluating a management team’s capital-allocation skills, Morningstar analysts bear in mind that some results have more to do with luck than management’s skill--particularly pertaining to short-run results--and instead put themselves in management’s shoes at the time the decision was made.
In other words, we want answers to questions like these:
Because one can take all the right steps in evaluating a stock only to have the market fall or have another unforeseen event lead to poor short-term results, we want to learn more about the company's decision-making process for acquiring another company, starting a joint venture, investing in growth capital expenditures, or repurchasing stock. As Michael Mauboussin puts it in his book The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing, "When a measure of luck is involved, a good process will have a good outcome but only over time."
Realizing that luck is often fleeting, Morningstar analysts want to determine the thoroughness of management's investment evaluation process and whether recent successes and failures have altered that process. This, we believe, will tell us more about the quality of the firm's general capital-allocation decisions than what short-term results might suggest.
Admittedly, outside of sitting in a room with the CEO and CFO as they evaluate investment opportunities, it can be difficult to evaluate management's capital-allocation decision-making processes. That doesn't mean we shouldn't try, of course.
Here are 10 areas that we look into when evaluating stewardship:
Answering these 10 questions should help you understand how well management is allocating capital, whether or not management's interests are aligned with your own, and whether management treats shareholders as partners or simply capital providers. In other words, you'll be able to decide whether or not you want to invest in the company for the long term.
In the comments section below, please post any questions or feedback that you have.
Todd Wenning is an equity analyst and leads Morningstar's stewardship methodology. You can follow him on Twitter at @toddwenning.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals
and individual investors. These products and services are usually sold through
license agreements or subscriptions. Our investment management business generates
asset-based fees, which are calculated as a percentage of assets under management.
We also sell both admissions and sponsorship packages for our investment conferences
and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.