In our previous article, we learned Buffett's three business tenets. In this article, we are going to look at three management tenets of Buffett. These tenets are nothing but qualities that Warren Buffett expects the management of companies to possess. We once again would like to remind you that these tenets are from the book 'The Warren Buffett Way' by Robert G Hagstrom, and if you like to know in-depth, you can read the book (which is also recommended because it's really good). Now let's not waste time like food blog intros and go straight to the point.
- Rationality: Being rational means doing things based on reason and logic. Warren Buffett expects the management to be extremely rational when it comes to capital allocation. Managers have to decide what to do with earnings; whether to reinvest or return to shareholders. But why the choice? Why not reinvest everything all the time? Because what they reinvest should generate a return more than the cost of capital. What's the use of reinvesting if it doesn't generate the cost they incur to get the capital. If a manager can't reinvest at above average return on capital, then it is better to give dividends or do buybacks. Godrej Consumer Products is a great example of this. The company wasn't adamant about reinvesting into the business and whenever they didn't have a proper avenue to invest, they opted for buybacks.
- Candor: How free and transparent is the management towards its shareholders? Management should communicate both success and failure with its shareholders. Why? Warren Buffett says management's comments should give us answers to three questions: a) What is the approximate worth of the company? b) Can it meet its future obligations? and c) How well are the managers performing? Free and proper communication will be useful to arrive at the answers. Ashiana Housing is regarded to have one of the best management in the real estate sector. They are not only open about how the sector is performing but also disclose project-wise cash flows in detail that many players do not do.
- Institutional imperative: This is nothing but having a herd mentality. Is the management doing what every other company is doing to be safe or are they doing what is actually good and will improve their business? This can be better understood with an example. When all the players were sticking to just scooters, Bajaj Auto was brave enough to venture into the motorcycle segment. The rest is history as they became segment leaders and expanded their export business. Even recently, unlike Ola and Hero who are venturing into EVs right away, Bajaj Auto has chosen to take its time to gain adequate expertise and not rush into it.
Also read:
Buffet's business beliefs
Five pointers to find a moat
Peter Lynch's six stock categories
Six parameters to look for in a company before investing
