To reduce a universe of potential investments to a few to study and perhaps even buy, ask a few threshold questions. For example, to pass the sentry, a business must answer, "yes" to: "Are you run by experienced leaders who allocate cash to increase shareholder value?" (Last week's question was whether the financials clearly convey the business model and health, allowing the investor to evaluate risk.)
Today, the first half: Who on earth are "experienced people?" Answers to this question line bookshelves, fill terabytes and checklists pages long. Our own How to Evaluate Management special should be every investor's bedside reading. But here are some quick tools to get you started and narrow your candidates for more detailed work.
I simply want managers who are experienced in the task at hand. That means either that they have a track record in the industry or in turnarounds, or both. I make exceptions for a few stars that could probably lead any company, any time. But while I admire visionaries with more dreams than experience, I like to see experienced senior management with complementary skills.
This is easy to ascertain. Simply use our Quotes & Data service or www.sec.gov to find the annual report Form 10-K or Proxy Statement Form DEF-14 to read up on management's background (available through the Fool or www.sec.gov). Make your life easier by using CTRL+F to search through your online documents by keyword.
Almost all websites for publicly traded companies contain bios of top management. It's not a good sign if they don't or if details are sketchy.
You don't necessarily need experience in a particular industry if you are just plain stellar. When General Electric (NYSE: GE ) made the difficult choice of Jeffrey Immelt over two competing execs, it left Home Depot (NYSE: HD ) free to hire Robert Nardelli, CEO of GE's Power Systems division, and 3M (NYSE: MMM ) to grab Jim McNerney, president and CEO of GE's Aircraft Engines division. Each firm got quality. Investors considering these companies would have to give these two passing grades at the start.
But apart from that limited universe, you want industry experience, turnaround expertise, or both.
Consider Oxford Health Plan's (NYSE: OHP ) mishandling of a computer conversion and resulting misstatement of revenue in 1998. The company ousted the founder and brought in Norman Payson, who had started, run, and sold a successful health-benefits plan manager to Cigna (NYSE: CI ) . He didn't plan to stay forever, so he hired and promoted top managers with industry experience. Management righted the business and regained investor confidence.
Ailing drugmaker Schering-Plough (NYSE: SGP ) hired Fred Hassan, who revived Pharmacia and sold it to Pfizer (NYSE: PFE ) last year for $60 billion. Here, you have an experienced turnaround exec with a track record in the same industry. Zeke Ashton recently appraised the prospects for Hassan's success in Schering-Plough's Tough Row.
Bankrate (Nasdaq: RATE ) turned to Elisabeth DeMarse in 2000 after its 1999 IPO and subsequent downward spiral. She had key experience in the online financial and advertising world with Hoover's, Bloomberg, and Western Union. DeMarse faced a tough task but had the right stuff.
Bankrate kept losing money and its shares dipped to $0.19 after Christmas 2000 and were delisted from the Nasdaq a month later. DeMarse and her team started squeezing free cash flow in 2001. The stock recovered a little, but investors really didn't catch on until the second half 2002. As free cash flow accelerated, the stock began to catch fire, rejoined the Nasdaq SmallCap Market early this year, and ascended to the National Market in August. It closed yesterday at $13.51, providing a nice 7,011% gain from Dec. 26, 2000. Quite a Christmas present -- a gift that kept on giving.
The task at hand
When another ailing drugmaker, Elan Pharmaceuticals (NYSE: ELN ) crashed, it confounded critics and chose an industry outsider, G. Kelly Martin from Merrill Lynch (NYSE: MER ) . But the Elan board made a smart decision. It already had experienced pharma people in other top positions; it needed someone to unravel the labyrinthine financial structure, restructure and pay off debt, and avoid bankruptcy. Martin brought 21 years of turning around troubled operations inside the financial services giant. Good choice.
And Martin has made great progress, leading investors to raise the stock from its $1.17 close on Oct. 9, 2002 to yesterday's $5.33. Jeff Hwang snapshots the company in Elan's Bitter Pill.
Vision plus experience
Vision is necessary for a business that wants to upend the established order, but it's best to have some experience on the team. Young, brash and brilliant founder and CEO Doug Lebda had the good sense to hire skilled senior people at online lending exchange LendingTree, which he eventually sold for a 48% premium to InterActive Corp. (Nasdaq: IACI ) -- after the business had recovered and the shares quadrupled off their lows.
eBay (Nasdaq: EBAY ) founder Pierre Omidyar stepped aside as CEO prior to the IPO, ceding the executive suite to former Hasbro (NYSE: HAS ) chief Meg Whitman. At Amazon (Nasdaq: AMZN ) , Jeff Bezos has surrounded himself with senior execs that sport 20 years at GE, the same at Deloitte & Touche, and seven at Wal-Mart (NYSE: WMT ) , for starters.
Applying these simple tests makes it easy to spot pretenders to the executive thrones. Those who examined Al Dunlap's experience prior to Sunbeam steered clear, and investors familiar with Gaston Bastiens' sub-par tenure at Quarterdeck avoided the Lernout & Hauspie debacle.
Investors considering Elan Pharmaceuticals before its blow-up might have noticed that top execs had been partners at accounting firm KPMG. No wonder they cottoned to special purpose entities -- the same that imploded Enron -- to carry off-balance sheet debt and fund all sorts of development deals. They were better at juggling balance sheets than developing and selling drugs.
A stitch in time...
With online access to so much information today, it's easy to get to know managements' backgrounds and gauge their chances of success in making you money. You can spare a half hour to apply the easy test: Does management stand in the star category ready to handle all, or is it at least experienced in the industry, turnarounds, or both?
Next week, the second half of the management test: Which execs do a great job allocating cash to increase shareholder value, how do they do it, and how can you tell? Once again, I'll name names.
Have a most Foolish week, and thanks for reading!