Management Quality: The Stock Market's Ultimate Intangible

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club

Management Quality: The Stock Market's Ultimate Intangible

by Alexander Green, Chairman, Investment U

Friday, May 25, 2007: Issue #678

Most stock market analysts look at numbers. Lots of them.

Value investors pour over balance sheets, income statements, dividend yields, p/e ratios and price to book. Growth investors scrutinize sales growth, operating margins, cash flow, earnings growth and return on equity.

Market timers, blinkered as their approach may be, look at the advance/decline ratio, new highs and lows, support and resistance levels, the put/call ratio, short interest and other broad market measures.

Yet one measure is critically important, but cannot be quantified. Measuring it is always highly subjective, if not completely impossible. Yet it is an indispensable indicator for determining how a business is likely to perform. I'm talking about quality of management.

Team Performance

While most investors focus on new products and services, profit growth, price action and other tangible measures, you should never lose sight of the fact that companies are simply teams of people. How well the team performs is due partly to the players and partly to the guy (or gal) calling the plays.

Imagine, for example, the history of McDonald's without Ray Kroc, Intel without Andy Grove, Berkshire Hathaway without Warren Buffett, Microsoft without Bill Gates, Wal-Mart without Sam Walton or Apple without Steve Jobs.

These men played indispensable roles in making long-term shareholders exceedingly wealthy.

When I assess the quality of management in companies I'm considering recommending, I look at two primary factors: experience and attitude.

In February 2003, for example, I liked Netflix (Nasdaq: NFLX) due largely to the strategy of hard-charging CEO Reed Hastings.

At the time, the stock had been beaten down as investors feared that Netflix, a company that rents DVDs online, would get steamrolled by two competitors, Wal-Mart and Blockbuster.

But I knew Hastings was no shrinking violet. A seasoned executive who had already made shareholders a tidy sum running Rational Software - before it was bought out at a healthy premium - he quickly drove Wal-Mart out of the online DVD rental business and Blockbuster practically into bankruptcy. (Blockbuster has since rebounded.)

We ended up stopping out of Netflix with a 262% gain in nine months.

I made a similar judgment with red-hot footwear retailer Sketchers (NYSE: SKX) last year. CEO Robert Greenberg, who was responsible for the meteoric success of L.A. Gear, said he was intent on turning Skechers into not just a mega-brand, but "a monster."

I went out on a limb, calling the footwear firm "the next Nike." Since then the company has experienced a surge in both sales and earnings. In the 12 months since we bought in, the stock has nearly tripled the return of the S&P 500.

Leadership Management Qualities Worth Investing In

There are many qualities that create exceptional leadership, of course. Among them are determination, creativity, intelligence, drive, and vision - to name just a few. But great leaders are also good at making everyone feel like an integral part of the enterprise.

And not just at Fortune 500 companies...

Last month in Forbes, columnist Rich Karlgaard described an excellent example of business leadership. It was told to him by Nancy Ortberg, an emergency room nurse, who was finishing up work one night before heading home.

"The doctor with whom I was working was debriefing a new doctor, who had done a very respectable, competent job, telling him what he'd done well and what he could have done differently.

"Then he put his hand on the young doctor's shoulder and said, 'When you finished, did you notice the young man from housekeeping who came in to clean the room?' There was a completely blank look on the young doctor's face.

"The older doctor said, 'His name is Carlos. He's been here for three years. He does a fabulous job. When he comes in he gets the room turned around so fast that you and I can get our next patients in quickly. His wife's name is Maria. They have four children.' Then he named each of the four children and gave each child's age.

"The older doctor went on to say, 'He lives in a rented house about three blocks from here, in Santa Ana. They've been up from Mexico for about five years. His name is Carlos,' he repeated. Then he said, 'Next week I would like you to tell me something about Carlos that I don't already know. Okay? Now, let's go check on the rest of the patients."

Ortberg recalls: "I remember standing there writing my nursing notes - stunned - and thinking, I have just witnessed breathtaking leadership."

It's this caliber of leadership you should look for in the public companies you own. It's also the kind of leadership we should strive to bring to the people we work with ourselves.

It makes everyone a little richer. And I'm not just talking about the bottom line.

Good Investing,

Alex

Today's Investment U Crib Sheet

  • Intangibles, by nature, don't show up on a company's annual report. But there are a few things you can do to get a sense of upper management's attitude. One way is to get on the quarterly conference calls they hold to discuss financial results and guidance. And stay on the call all the way to the end. That's when you'll hear Wall Street analysts ask CEOs and CFOs to comment on concerns they may have about past performance, competition and future growth. See how the company's top executives respond. Unless you can set up a private appointment with Steve Jobs or Warren Buffett, these calls are your most direct access to management.
  • What about their track records? If a management team has been in place for more than a year, get copies of the company's annual reports from one, two, and even three years ago. Look at the guidance they've provided in the past. Then compare it to the company's actual results. Of course, its stock price should reflect management's track record, too. (Annual reports - 10Ks - can be downloaded at www.sec.gov, or the investor relations page on a company's website.)

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