How to find quality management?

In 2018 if you will check, the 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 the stock crashes, actual research should start much before you decide to buy that stock. So what you should check to find Quality management?

This is my checklist to understand management :

1.Management Remuneration :

Management can get their Remuneration in 2 ways. One by holding a 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 the management focuses 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 a company has 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 a 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 a 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 the company but if the owner itself is managing the business then he should focus more on business development.

2. Are they paying taxes?

To check a basic level of integrity we should check if the company is paying enough taxes or not.If they are not loyal to government then mostly they will not take decisions that are shareholders friendly. In manpasand beverages case first auditors resigned without giving any reason and the 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 is management treats employees? Are employees happy to work with the organisation ? Are they paid enough? What is the culture in the organisation ? These are subjective questions and answers will depend on the particular individual, but we will get more insights of the company by asking these questions.

4. Are they declaring dividends?

This is another check for management. If a company is profitable then are they declaring dividends? Dividend declaration depends on many things like the company’s debt position, growth target, and growth CAPEX. Ideally, the 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 Hathaway never paid any dividend 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 is management using the remaining profits?

5. What is succession planning? 

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

6. Check the performance of management when the economy in slowdown

When the 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 the 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 the economy is in a 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 the 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 the long run. 

8.Short term or long term vision?

We should check the vision of the 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 the managements’s focus on immediate profits and then it affects the performance in the long run. We should avoid such managements.

9.Over-commitment/Under delivery

This is another problem with growth-oriented management. 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 a consistent basis are one of the best management.

10.Diversification / Cash holding

Is management doing unnecessary diversification? Focusing on core business always helps in the long run, so we should check if management is entering into completely new sectors. We should also check how much cash they are holding and for 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 are 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 management by commenting below. 

I have created a video on this topic, you can check below