It is important to invest in a business run by a credible management team. After all, it is the management that can make or break a business. If management is the driver of the business, investors are co-passengers. However, if the driver commits any mistake, then co-passengers have to bear the brunt equally.
Aviation, which is one of the toughest industries, provides two contradicting examples: Jet Airways and Interglobe Aviation. While Interglobe has dominated the industry through its low-cost strategy and management proactiveness, Jet Airways has lost its momentum because of ineffective management.
When it comes to evaluating management quality, the following things should be taken into consideration.
Compensation: The compensation of a company's top management should be commensurate with its profits. SEBI guidelines and provisions of the Companies Act, 2013 provide specific limits for managerial remuneration and lay down the procedure wherein approval by shareholders is required if the limits are breached. One should read the notes to the accounts carefully to analyse the compensation of the top management.
Innovation: Companies that don't innovate are likely to go out of business sooner rather than later. Hindustan Motors, an early entrant in the Indian car market, did not innovate and gradually lost ground to its competitors. Therefore, an investor should check the management's track record of dealing with change.
Education and skills: Top management's education and skills indicate the management's business acumen. Complex businesses like pharma and chemical require a management with extensive experience.
Past decisions: An investor should also analyse how a company has addressed challenges in the past. For example, in 2009, Reliance KG-D6 basin was expected to be the major revenue driver for Reliance Industries. However, in 2010, the production from the basin started declining. Hence, Reliance gradually started shifting its focus to the Indian digital space and telecom market. Nine years later, it is the second largest telecom operator in India.
Stake and pledging: If the promoter holds a significant stake in the business (50 per cent or more), especially in small companies, it is a potential positive, since it represents his skin in the game. On the other hand, a falling promoter stake is a sign of caution.
If a promoter holds high stake but has pledged a majority of his stake, then his effective stake is significantly lower than it looks. Pledging is a huge risk for an investor since it can lead to a significant drop in share price if lenders decide to sell the pledged shares. The fall in share prices of Zee Entertainment, Eveready Industries and others in recent years exemplifies this fact.
Apart from analysing these points, investors should also keep a tab on management commentary and interviews on a regular basis.