This article first appeared in the Australian Financial Review on September 05, 2017.
Talking to a company’s leaders would seem a commonsense way to turbocharge one’s knowledge of the business. Curiously, though, not all investors agree.
Some say talking to management teams can leave you starry-eyed as the corporate gladiators who reach the C-suite typically can yield charm like a mace.
The sceptics are on to something. Still, just like actually meeting one’s future spouse in person is a better path to a figuring if there is a fit, marrying hard facts with a qualitative read can make for the best outcomes when it comes to sizing up management. Even better, you don’t have to be a professional investor to put some of these techniques to work.
A good starting point in sizing up a company’s management is to dig up data on ownership and insider transactions. The more skin in the game a manager has, the more you can reasonably expect that they will act in the long-term interests of shareholders.
High insider ownership, particularly among founders, also signals something valuable but less subtle – attractive economics. Founders who still own large stakes in their companies are likely to be managing businesses that don’t need much external capital to grow quickly, so they’re probably sitting on a business that can earn high returns on the little cash it does need to reinvest into the business.
Meaningful insider buying also makes for a strong signal from the people who should know best.
Reading into insider selling isn’t as simple, though. True, I smell a whiff of smoke if an executive reduces a stake as the company nears a financial announcement or sells off a significant portion of holdings. Then again, I can also think of many valid reasons why aging executives with the majority of their wealth in a single asset might choose to diversify or take some chips off the table.
Consider the case of Netflix. The company’s CEO and co-founder, Reed Hastings, has progressively reduced his ownership stake by about 70 per cent over the past decade after adjusting for splits and options. A red flag? Maybe, but I don’t hear too many long-term shareholders griping about the shares’ 74-fold return over the past 10 years.
It also pays to evaluate the factors that affect management’s strategy.
Just like a typical dog will sit or roll over for a biscuit, a typical chief executive who is offered big bonuses to grow revenue or earnings before interest, tax and depreciation will acquire, borrow, or capital raise his or her way to making it happen. I much prefer to see managers incentivised based on per-share terms to make sure they do not dilute away the farm.
All those factors are important and can be cobbled together from annual reports and other company filings.
For the annual report, skim down to the remuneration section for details on how the board and key executives are compensated, including what metrics they’re incentivised to hit, the payoffs for success and over what time horizon. Objectives that don’t align with long-term value creation or that look like six-inch-hurdles are red flags.
What’s less obvious are the qualitative factors around integrity, culture and capital allocation. This is where sitting down with management and asking probing questions can fill out the picture.
The bad news is that everyday investors don’t have the same kind of ready access to company leaders as, say, brokers, analysts or fund managers. The good news is that individual investors aren’t left out in the cold when if they’re patient, respectful and willing to do a little homework.
Leaders at big companies aren’t likely to take your phone call.
Amazon.com’s Jeff Bezos, for example, once said that he spends only six hours a year talking to investors. Still, large companies usually have helpful, enthusiastic investor relations teams who are happy to chat with friendly folks who have made an effort to ask informed questions.
Your odds of breaking through to management are much higher at smaller companies as their leaders receive far less attention. And be sure to pay attention when you get in touch as most companies don’t speak to the investment community for weeks leading into reporting season.
Many give shareholders access to the conference calls they hold when they announce their half-year and annual results, and many smaller companies are happy to let individual investors ask questions on the call. Try skimming to the bottom of the press release of a company’s announcement of results to find the call details, and take note that the calls usually happen shortly after the release.
Missed the call? You’re probably out of luck, although some companies post transcripts or recordings to their investor relations page on the website. And, if they held a call and didn’t create a way for investors to go back and listen later, don’t be shy about diplomatically requesting that the company do so in the future.
And yes, shareholders are also free to ask questions at annual general meetings. Even Bezos answers questions from investors at the Amazon AGM.
Now comes the hard part: making the most of your time with management by asking highly effective questions. Brushing up on what’s new with the company, including its latest financial reports, is a logical starting point, as is focusing on the business’s future and long-term prospects.
In my experience, there’s nothing as refreshing to an executive as a shareholder who cares more about the long term than the short term. Good long-term topics that are useful and straightforward enough for everyday investors to run with include what a CEO thinks of a new competitor, how the company differentiates in the marketplace, what part of the business isn’t living up to their expectations or when the company might expect to pay dividends.
Again, be respectful, but don’t be shy. How managers communicate with investors speaks volumes, so be sure to listen. And if the response is silence? Well, that speaks volumes too.
Joe Magyer is the chief investment officer of Lakehouse Capital. He owns shares of Amazon.com. This article contains general investment advice only (under AFSL 400691).