Bad directors rarely become good directors Richard Crowe (aka the Cockney Rebel)
I listened to an excellent podcast recently on PI World with well known investor Richard Crowe a.k.a. Cockney Rebel. He has developed a specialism in buying shares in turnaround situations. In the course of the podcast he talked about several companies which he has invested in recently and how the common denominator was good management.
It is a truism that if a company is well run then the cards are stacked in its favour. Conversely bad management means that any company, however great its ideas, will have an uphill struggle if it wants to succeed. To quote a rather memorable phrase from investor Nigel Wray, a fish usually rots from the head.
So what makes a good manager? Warren Buffett has spoken extensively about this. He wrote about Tom Murphy of Cap Cities- such an example:
I mean, no one had either the ability -- no one could top his ability or integrity, in terms of the way he ran Cap Cities for decades. I mean, and you could see it in 50 different ways. I mean, he was thinking about the shareholders. And he not only thought about them, he knew what to do to forward their interests, and -- In terms of building the business, he only built it when it made sense, not when it did something for his ego or to make it larger alone. He did it when it was in his shareholders' interests.
The key to Murphy's success was his ability to always put the interests of shareholders first.
And what are the primary interests of shareholders?
Well simply to build profitable, growing, sustainable businesses. Good managers get this. They are not there to serve themselves. They are there to serve the interests of their shareholders.
The other measure of good management was also described by Buffett in 1994:
I think you judge management by two yardsticks. One is how well they run the business, and I think you can learn a lot about that by reading about both what they’ve accomplished and what their competitors have accomplished, and seeing how they have allocated capital over time.
So we have three measures of good management from one of the best investors of all time:
1. Serve shareholders above yourself
2. Run your businesses well
3. Allocate capital well.
I'm a firm believer that there is nothing new under the Sun. Two millennia ago Jesus Christ told the story of management A master put his servants in charge of his goods while he is away on a trip. Upon his return, the master assesses the stewardship of his servants. He evaluates them according to how faithful each was in making wise investments of his goods to obtain a profit. A gain indicated faithfulness on the part of the servants. The master rewards his servants according to how each has handled his stewardship. He judges two servants as having been "faithful" and gives them a positive reward. To the single "unfaithful" servant, who played it safe, there is punishment.
A good manager of a public company is fundamentally required to be a good steward. He or she is entrusted with the stewardship of the company by the shareholders and is required to run it well in the best interests of shareholders, allocating the capital he or she has at his disposal as best as he or she can.
So how do you go about finding these great managers?
Well don't just look at share price performance (at least in the short term)- the Dotcom boom of the late 1990's is great evidence of that. The truth is that here are many bad managers who are able to dupe people into buying the shares of the Company for sufficient lengths of time. In fact you see this in all walks of life.
I have worked alongside people who are great managers. I've also worked alongside some who are rank awful. The good managers tend to stay around. In fact they only tend to move on when their potential is realised and they move on to bigger and better things- but usually only having made a meaningful difference to where they were.
The bad managers will last a much shorter time- typically until they are found out and are tend to jump before they are "required" to. I am far too polite in this blog to name any high profile examples in listed companies of bad short term managers, but there are (sadly) plenty of examples that exist..
So longevity is one thing. Clarity of mission is another. Can the Manager (or Management) articulate a clear mission statement- a vision of what they are setting out to achieve?
Professional fund managers do hold an advantage over private investors in that they can sit down with management and not only hear their mission statement, but also interrogate it. Whilst it's easy to be despondent and say "well I simply don't have the chance to do this as a private investor", actually there are ways. Look at a good UK growth fund (I particularly like Mark Slater's UK growth fund) and see what companies they are holding there. Rest assured that a good fund manager (like Mark Slater) spends an awful lot of time with management. They don't generally invest their own investors funds without being satisfied that the management is strong.
Thirdly do they back the clarity of their mission statement by sticking to their core operations and not needlessly diversifying? Grizzled investors often refer to this tactic as "diworsification". It is often a surefire way to destroy shareholder wealth Do they sell off non-core divisions for a fair price so that they can invest properly in what they know?
Fourthly do they demonstrate belief in that company by regularly buying and holding shares in their company? This is often something that I look for when deciding whether or not to buy shares in a company- regular director buying is often a sign that directors believe that their company is not fully valued. Equally if they are selling shares without good reason then that can be cause for concern. Do they know something they are not telling us.
Fifthly do they pay themselves appropriately? Good managers deserve to be rewarded. Equally if a company is not doing well or the macro-economic climate changes (like it did in March 2020) that is not the time to be awarding pay rises or even not thinking seriously about pay cuts. Some public companies I knew decided to take a 25-30% pay cut across the whole Board in March 2020. In truth, with suspension of dividends, it was the only appropriate response.
Sixthly are they using both equity and debt capital prudently? The best companies reinvest their profits to create long term sustainable wealth. Debt can effectively be used to amplify this. However it should also be used prudently. As an investor, in terms of managing my own risk, I tend to steer clear of companies with high levels of debt. All it takes is for one wrong term and the debt holders will step in. Oh and they tend to scrutinise good management more closely than you or I...
So there you have my six steps for judging good management:
1. Longevity of service
2. Clarity of Mission
3. Focus on growth of core operations
4. Regular purchase of shares in Company
5. Sustainable pay
6. Intelligent use of capital
Good luck in finding these managers and do let me know if you find any!