Focusing solely on financial metrics and valuation models can be alluring when evaluating potential investments. However, assessing the management team is crucial.
Understanding the Business when Evaluating Management
To provide some fundamental context, investors should work to understand the company’s underlying business model and competitive environment using the Business aspect of the BMPB framework. For example, what product or service does the firm provide, i.e., how do they generate revenue? Who are the major competitors? How large is the total addressable market?
This grounding in the fundamentals of the business is a critical context for evaluating the aptitude of management.
Evaluating the Management Team
With a basic understanding of the business, the Management element focuses on the human capital leading the company. Some essential questions to answer:
- What is the capital allocation track record of the executive team? Have they demonstrated prior success at this company or in this industry concerning the company’s growth, from either organic growth or mergers and acquisitions? What’s the company’s dividend policy, share buyback program, and debt management on the balance sheet, and do these activities align with shareholders?
- Are management incentives adequately aligned with shareholders? Or does executive compensation appear skewed too heavily toward the short term?
- Does the management team exhibit integrity, transparency, and accountability with shareholders? Or do they seem only to pay lip service to investors?
- Is there high turnover or departures of critical executives that raise a red flag? Does talent thrive and stick around at the company?
- Does the board include respected leaders who can advise and challenge management as needed?
Why Management Matters
Investors who overlook management diligence and focus narrowly on short-term financials or valuation multiples often regret that decision later. Some reasons that evaluating the management team matters so much:
- Executives make crucial capital allocation decisions that impact long-term business value. Suboptimal choices can destroy shareholder wealth.
- Management sets the corporate culture and morale as vital intangible assets. Talent retention needs better leadership.
- Execs are closest to the business operations and competitive landscape. Investors want managers to think strategically for the future.
- Management guides the investor relations tone and transparency. Secure executives engage openly with shareholders.
Takeaway
Analyzing business strategy is only complete with a robust examination of the management team executing that strategy. The management team’s capital allocation track record, incentives, and the company culture they set provide valuable insights. The GW Investment Institute BMPB framework emphasizes evaluating the management team.