It’s certain that it would be extraordinary to be able to find future stars before they are known!
I would say, however, that the assessment of a management team is very subjective and that it is largely based on judgment and interpretation. In addition, each investor will have their own selection criteria based on their personal values. For example, many swear by Elon Musk, the founder of Tesla, while I, for one, disagree with many of his ways of doing things.
To lighten the exercise, I thought I would use the example of an American company that I analyzed in detail recently and which, in my eyes, contains several of the elements that I seek in terms of the quality of the management team. Here are some of the criteria I would use to rate the management team at this company (which I will not name). In order to make reading easier, I plan to split this blog over a few weeks:
- The history of long-term value creation of the company with the current management team.
If a president has been in charge of a company for many years, you should be able to get a good idea of his performance by examining the evolution of its stock since his appointment. If the president was recently appointed, then we can trust her track record – has she created shareholder value in the past?
In the case of the company I analyzed, the current president was appointed in 2014, which is a relatively short period to assess his work. However, he has worked for the company since 1983 and has risen through the ranks over the years. He was previously named VP Information in 2009. It can be said that he knows the company culture very well and has certainly had an impact on the company’s performance over the past many years.
Since 2014, the stock of the company in question has recorded an annual compound return of 12.6% (without taking dividends into account); in 10 years, the annual compound return has been 10.3% (always without dividends) and 13.7% over 20 years (without dividends). In short, in terms of value creation, I think we can say that the management team passes the test with flying colours. Grade: A +.
- The executive management compensation philosophy.
Personally, I believe that executives who do exceptional work and create long-term value for their shareholders should be paid handsomely. On the other hand, the opposite is perhaps even more important: those who don’t deliver the goods should not get rich on the backs of their shareholders. Ideally, we are looking for companies that have reasonable executive base salaries. Of course, the term “reasonable” is very subjective and will depend, among other things, on the size of a business and its industry. It’s a good idea to compare them to those of similar companies in the same sector.
In this case, the salaries of the executive officers seem particularly reasonable to me: all of its members have an annual base salary of $100,000 or $120,000. I have to admit that I have rarely seen this over the years; the only example that comes to mind for a large company is Berkshire Hathaway where Mr. Buffett’s annual salary is $100,000.
If we want senior executives to work for us shareholders, I believe their incentive to do so should be through compensation based on financial performance and long-term appreciation of the company’s stock.
Of course, the major part of the executive remuneration of the company in question is focused on the performance of the company, in the short term and in the longer term.
For the short-term portion, executive bonuses are calculated based on the financial performance of the company including growth in revenues, operating profits and earnings per share from year to year.
As for the longer-term compensation, it comes from the allocation of stock options to executives. In addition, each director is required to hold between ten times his annual base salary in company shares (for VPs) and 60 times for the president.
I would give the company an “A +” rating in terms of compensation.
- The shareholders of the company.
It’s difficult to find a better way for officers and directors to work for their shareholders than if they themselves are large shareholders. Again, the question is subjective: one cannot expect an executive who was not the founder of a company to hold a high percentage of its shares. You also have to consider the size of the business: owning 1% of a mega-business is probably more than owning 20% of a mid-cap company. What matters to me is the cash value of the shares that the leaders own.
The example company has a multi-billion-dollar market value and their executives (a total of 18 people) are second generation (they did not found the company). However, collectively, officers and directors own 1.2% of the company’s shares, which equates to a value of nearly $150 million, including almost $29 million for its president.
I believe that this is an ample amount for the leaders to keep a marked interest in the success of the company and in the appreciation of its stock over the long term.
The continuation next week where I will present other elements entering into the evaluation of the quality of a management team.
