FOOL ON THE HILL
How to Go Beyond the Financials

There's a lot more art than science when it comes to analyzing a company's management and culture, but applying some due diligence and common sense can yield important insights for investors. Savvy investors need to evaluate these factors before buying a company's stock. Whitney Tilson shares some tips on how to do this in today's column.

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By Whitney Tilson
September 4, 2001

In my last two columns, I've highlighted the critical role corporate culture and compensation play in determining a company's long-term success. Savvy investors need to evaluate these factors -- and other subjective ones such as management competence and integrity -- before buying a company's stock.

This, however, is easier said than done. Unlike financial metrics, companies are not required to report on their corporate culture or issue an unbiased assessment of their management's quality. So how can one figure out if a company's culture and management team are good, bad, or somewhere in-between?

It's not easy, but in this column I'll share a few tips. (For more on this topic, you may also want to check out The Motley Fool's special feature on evaluating management.)

Know what to look for
Before beginning any evaluation, it helps to know what to look for. In terms of corporate culture, I seek businesses where employees care about the company, each other, and customers. They share information and cooperate. They feel good about their jobs and are willing to go the extra mile.

As for management, I'm looking for ability and integrity. Both are equally important. The former is pretty straightforward: Is the management team capable and well-respected, and does it have a track record of success? 

Integrity is harder to gauge, but here are some of the questions I ask: Do managers underpromise and overdeliver? Are they frank in admitting mistakes?  Do they appear to be focused on promoting the stock to satisfy the short-term whims of Wall Street, or on building long-term value for shareholders? One of my pet peeves is when a company consistently beats consensus earnings estimates by a penny each quarter. It's a sure sign of heavy-duty earnings management, which can quickly spiral out of control if it becomes a corporate priority.

Okay, now that we know what to look for, where should we look?

Read annual reports
I highly recommend sending away for annual reports, rather than simply downloading a company's 10-K off the web, so you can read the CEO's annual letter to shareholders. It should be understandable, sensible, and thoughtful. Does its tone strike you as excessively promotional?  If so, watch out!  (There can, admittedly, be a fine line between a company putting its best foot forward and engaging in hype.) Does the CEO write about a company's culture and/or acknowledge the employees in a genuine way?

A company I've admired in the real estate arena is Vornado Realty Trust (NYSE: VNO), in part because Chairman Steven Roth writes such detailed and informative letters in each annual report.  If you want to learn about the insurance industry, I recommend reading Warren Buffett's annual letters to Berkshire Hathaway shareholders; if you want to learn about real estate, reading Roth's letters is a good place to start.

Speaking of Buffett, his letters -- honest, witty, and insightful -- are the standard by which all others are judged.  (I've recommended these letters before but let me be even more blunt: Any investor who has not read them is committing an act of negligence.  There's really no excuse, especially since the last 24 of them are available for free on Berkshire Hathaway's website.)  Buffett's letters are brilliant in many areas. For example, here is how he acknowledged his employees in the opening section of his most recent annual letter:

"It's appropriate here to thank two groups that made my job both easy and fun last year -- just as they do every year. First, our operating managers continue to run their businesses in splendid fashion... Our managers are a very special breed... And they stick with us: In our last 36 years, Berkshire has never had a manager of a significant subsidiary voluntarily leave to join another business.

"The other group to which I owe enormous thanks is the home-office staff...This tiny band works miracles [and] are a delight to be around.

"I should pay to have my job."

Don't you wish your boss lavished that kind of public praise on you?

Here's another example of a CEO who obviously cares about his employees and seeks to build a strong corporate culture, Office Depot's (NYSE: ODP) Bruce Nelson:

"We are committed to making Office Depot a more compelling place to work. Simply put, we want to be the industry's employer of choice...We want to provide a rewarding experience [to our employees] that enables them to enjoy a high level of job satisfaction and communicate that satisfaction by providing our customers with fanatical customer service."

A final example is AAON (Nasdaq: AAON), which acknowledges and thanks its employees by printing every one of their names in the back of its annual report.

Read earnings releases
While earnings releases don't contain the in-depth information that annual reports do, they are more frequent and can be useful in many areas such as evaluating how promotional a company is. Consider the opening sentence of Manugistics' (Nasdaq: MANU) latest earnings release, for example:

 "Manugistics Group, Inc., the leading global provider of Enterprise Profit Optimization(TM) (EPO) solutions -- the powerful combination of supply chain management and pricing and revenue optimization solutions -- for enterprises and eMarketplaces, today reported its first quarter results..." 

In my opinion, this sentence -- full of bluster and meaningless words -- epitomizes excessive promotion, and is one of the reasons why I consider Manugistics a company investors should be wary of

Listen to conference calls
Unlike annual reports and earnings releases, in which each word is carefully crafted and reviewed by lawyers, public relations specialists, and so forth, a manager's personality can come out during often-tense Q&A sessions at the end of conference calls. In one perhaps-extreme example, now-departed Enron (NYSE: ENE) CEO Jeffrey Skilling called one short-seller who questioned the company's accounting an "a--hole" during the first-quarter earnings call. 

Call a senior manager
OK, Bill Gates isn't going to take your call. You would still be surprised by how many CEOs or other senior managers are willing to take a phone call from someone who is interested in purchasing their stock (This is especially true of small companies, which is where -- now more than ever -- I think individual investors should be looking for stock ideas.) I never cease to be amazed at the information that can be gleaned by simply asking nicely.

Talk to employees
Most employees can quickly and accurately tell you about a company's management and culture, though finding one who's willing to do so is tough. If it's a retailer, visit a store and strike up a conversation with a clerk. To learn more about corporate culture, try calling the investor relations department and asking for a copy of the company's value or mission statement. (If there isn't one, that tells you something.) Then, ask about the company's culture. What's special about working for the company? Is turnover a problem?

Check out the media
Journalists can uncover valuable insights about a company, so when you call to request an investor information package, be sure to ask for copies of articles about the company. If it's a major company, you might also search the archives of business publications such as Fortune, Forbes, and Business Week.

Read message boards
Message boards sometimes have insightful information, often provided by industry insiders or current or former employees. In addition, one can find links to (or copies of) articles about a company. Just take everything you read with a grain of salt -- I've seen disgruntled shareholders or employees post blatantly false and defamatory information.

Conclusion
There's a lot more art than science when it comes to analyzing a company's management and culture, but applying some due diligence and common sense can yield important insights for investors.

-- Whitney Tilson

Guest columnist Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owned shares of Berkshire Hathaway, AAON, and Office Depot at press time. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous columns for The Motley Fool and other writings, visit http://www.tilsonfunds.com/