In a competitive global investing landscape, it’s not enough to look at only traditional metrics of a company’s financials. After all, what you are looking at is often a snapshot in time and usually from a rear view perspective. Perhaps more important, is to look for management’s “vision” for the future. Whatever investment discipline you subscribe to in your analysis, eventually you will reach a point where management becomes an important criteria to consider. The importance or significance of a solid management team should never be overlooked when you are contemplating becoming a shareholder in a company. I will present a few examples of really good management teams and some not-so-good ones.
I researched some of the key points that Warren Buffett looks for when evaluating company management. I found that he has identified key aspects of management that he looks for in companies in which he invests. They include:
- Buy back of shares where the buy back is in the company’s interests, for example where the company has surplus funds and the shares can be bought back at less than intrinsic value,
- Capability in allocation of capital,
- Managers who stick to doing what the company does best; ‘the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago,
- Ability and readiness to tackle tough problems as they arise,
- The use of retained profits to increase company profitability at beyond market rates,
- A conservative approach to debt and liquidity, and
- Demonstrated ability to consistently grow company earnings and rates of return.
Warren Buffett has, throughout his career of public announcements, identified some things that he does not like in company managers:
- Managers who pursue company acquisitions for reasons other than the good of the company – ego trips, the ‘institutional imperative’ of keeping up with other company acquirers, bad judges (they buy a toad and think that it will turn into a princess when they kiss it); as he famously said in 1981, ‘[M]any managerial [princes] remain serenely confident about the future potency of their kisses – even after their corporate backyards are knee-deep in unresponsive toads’,
- Managers who pursue growth for growth’s sake, irrespective of the value of that growth to the company,
- Managers who expend too much of the company’s worth by issuing valuable shares to buy overvalued assets or who use debt to do so, and
- Managers who enrich themselves at company expense by with extravagant salaries and the abuse of share option arrangements.
So let’s review some well-known companies.
Yahoo! shareholders have paid CEO, Carol Bartz, $60 million so far for her last two years of work. In 2005, before she arrived, Yahoo! invested $1 billion into Alibaba Group in China. Today, 6 years later, that investment is worth $10 billion.
In an SEC filing in May, it was disclosed that Yahoo’s ownership of Alibaba Group’s online payment business, Alipay, was restructured so that 100% of its outstanding shares are now held by a Chinese company. Yahoo’s China investments had been widely viewed as among Yahoo’s most valuable assets.
The stock’s reaction was to drop from above $18 and now sits below $13. Someone really dropped the ball at Yahoo. Nice job!
Bank of America (BAC)
Several shareholder suits claim that the board of directors and some officers issued false and misleading statements that hid defects in mortgage recording and foreclosure paperwork. They claim that Bank of America did not properly record many of its mortgages when originated or acquired, which severely complicated the foreclosure process when it became necessary. The bank also concealed that it didn’t have adequate personnel to process the large numbers of foreclosed loans in its portfolio.
The directors and officers also hid the bank’s involvement in “dollar rolling,” omitting billions of dollars in debt from its balance sheet, according to the law suit. Bank of America later admitted it wrongly classified the transactions as sales when they were secured borrowing, according to the complaint. The investors accused the board and senior management of a breach of fiduciary duty, abuse of control, a waste of corporate assets, gross mismanagement and unjust enrichment.
Bank of America proposed $8.5 billion settlement over mortgage backed securities (MBS) which was rejected, which made investors worry that liabilities might cost much more and be an indication of future failed attempts to resolve lawsuits. According to SEC filings, Brian Moynihan, the CEO, earned $10 million for 2010. Just today, Bank of America announced 10,000 job cuts. And the shareholders…..?
Hewlett Packard (HPQ)
Until yesterday’s announcement, HPQ was the world’s biggest PC manufacturer. In August of 2010, HP CEO Mark Hurd resigned suddenly, following a sexual harassment probe that revealed he had falsified expense reports, ostensibly to hide a personal relationship with a company contractor.
Six months earlier, Hewlett Packard made a $1.2 billion acquisition of Palm. It was touted as follows: “The combination will accelerate HP’s growth within the more than $100 billion connected mobile device market. The combination gives HP significant headway into one of technology’s fastest-growth segments with Palm’s innovative webOS platform and family of smart phones, plus a rich portfolio of intellectual property from the smartphone pioneer.”
The company initiated a global search for a new CEO and selected Leo Apotheker, 57, former CEO of SAP (a software company). He served as sole CEO for about a year at SAP, and spent over 22 years at Oracle. It leads you to question what exactly the Board was thinking when they chose a lifetime software guy to run a hardware company? Some smart investors weren’t buying into the change in leadership as the shares never recovered after Hurd’s departure. Many Wall Street pundits kept touting the shares as absurdly undervalued. Value, or value trap?
The company went on to produce an “iPad killer” called the Touchpad. Touchpad sales have been dismal. Best Buy reported selling only 10% of their initial order. In response, HP management announced yesterday that were shutting down all webOS products AND were exiting the PC business altogether. Instead, they are buying a U.K. software company and paying ten times sales. Total investment, $10 billion.
Apotheker has shown his true colors, that is, software over hardware. It is estimated he may earn as much as $85 million in the next five years. And the shareholders….?
62 million people eat at a McDonald’s every day. They are the biggest distributor of toys in the world. For the next three years, they will open a new restaurant in China every day.
At McDonald’s, talent management is well-honed and almost scientific. They are able to react based on the demands of consumers. They are able to provide what customers want and that is the most important factor of all because without the consumers, they will not succeed. Systems, people and the ability to give what the customers want are the reasons why McDonald’s is as successful as it is today.
Part of their globalization success is that they customize their menus for the country that they operate in. In short, their adaptability is their key to success. In Arab countries, you’ll find “Halal” menus, which signify compliance with Islamic laws for food preparation, especially beef. In addition, restaurants in Saudi Arabia do not display statues or posters of Ronald McDonald, since the Islamic father prohibits the display of “idols.” How about a kosher McDonald’s? The first one opened in early 1995 in a suburb of Jerusalem. It does not serve dairy products, and is closed on Saturdays, the Jewish Sabbath.
The growth of McDonald’s to date – domestically and internationally – has proven the validity of the first thought through Ray Kroc’s mind when he initially saw McDonald’s in operation: “This will go anyplace.”
Their vision statement is as follows: “Man is the creator of change in this world. As such he should be above systems and structures, and not subordinate to them.”
Apple has topped Fortune magazine’s list of “Most Admired Companies” four years running. Just last week, Apple became the world’s most valuable company (by market capitalization) overtaking Exxon. Apple’s 30 plus year history is full of ups and downs. From product flops to Steve Jobs getting fired and then coming back, health concerns, medical leaves, succession plans, etc.
Apple’s greatest strength is product differentiation. They have never been afraid of taking big steps to break away from the industry and move in a different direction. Examples include: button-less mice, translucent computers with no disk drives, and cell phones that operate with the touch of a finger.
One great example of this differentiation is the “open” vs. “closed” approach to product development. Apple has adopted the “closed” approach of developing both hardware and software. This has allowed them to be in full control of the customer experience. While it can be argued that customers are better off with many different product suppliers, customers have voted with their money and sales of all product categories are experiencing impressive sales growth and margins that other manufacturers can only dream off. In June of 2011, I uncovered a startling fact: based on publicly available data, Apple made more profit on 1 Mac than Hewlett Packard made on six PCs (see HPQ above).
In his new book “Good Strategy, Bad Strategy: The Difference and Why It Matters,” Richard P. Rumelt, a strategy professor at UCLA’s Anderson School of Management, offers another explanation on Apple’s success: the ruthless execution of good strategy. Apple’s senior management team is quite impressive. Key areas such as industrial design, marketing, retail operations, and software are often copied by its competitors. Oh, and by the way, Steve Jobs annual salary is $1.