What should you look for in management of a large company?
There is a tendency to think about management the way your boss operates. Most times that is not management but rather administration. Administration is the dutiful carrying out of tasks created by more senior levels in the organization and performed by those you supervise.
Administration has some effect on the value of the business if poorly handled, but well-handled adds little.
Value addition will come from very high levels of management. There is just a single factor that matters. How well do they allocate capital? Capital allocation can be directed in several ways.
- Investment in producing assets. New plant, equipment or support and the inventory and receivables that follow.
- Investment in new products. Research and development. Marketing and launch,
- Acquisition of suitable businesses.
- Investment in better processes or employee development
- Reduction of Debt
- Payment of dividends to shareholders or repurchase of shares.
The basis for the decision will be how does the allocation impact free cash flow. Investment in anything must pay for itself and fairly quickly. Some businesses will permit a longer earn out but they have a low obsolesce factor. A pipeline business or railroad can accept a longer time than one who creates apps for a smartphone.
Reduction of debt changes the perceived risk of the business and may cause an improvement in the P/E ratio people will accept.
Same sort of shareholder welfare issue with dividends and buy backs. More people will want to own stock in the companies that treat them well and that pushes the share value higher.
Homeless dollars move off the balance sheet because having too much cash seems like a low value asset allocation. It is too, unless you MO e it and in the process waste it.
In businesses with cash and where capital allocation is not the strategic priority, what happens?
The homeless dollars end up in less well considered places. Some acquisition oriented companies run the business the way you might play Monopoly. Buy everything you land on. That tends to increase exposure to negative outcomes. No one is perfect. No acquisition goes as smoothly as people hope.
I suppose the buy everything approach approach might be better than investing in new office space, a mountain retreat or a fleet of corporate jets.
Business analysis involves more than just earnings. Quality of earnings matters too. Deferred costs and revenue recognition before delivery can be problems. The rule is cash and cash flow tend to be real, all other assets tend to be opinion.
Pay attention to longevity. How have they dealt with things in the past? Is there a management transition plan? Does the company tend to keep and nurture winning businesses? Do they over diversify? Are they a market and cost leader?
Most good businesses make sense. If they are too complicated, or if you don’t understand their industry, or if information is not readily available, you should pass.
Investing in a business is mostly common sense. How they handle the homeless dollar question is one indicator.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772