I know it sounds ludicrous, but investors often overlook the people in charge of protecting their investments. The idea of gauging a company's leadership plays second-fiddle to other categories of analysis. However, at Fool.com we believe careful study of effective leadership is one of the most important areas of evaluating long-term winning investments.

We like CEOs who actually work for shareholders like us. After all, we're the true owners of the business. When you're deciding whether to invest in a company, failing to vet its CEO is a big mistake. In fact, if you've overlooked the study of a company's leadership, then that's the one important area you should know about before finalizing your investment in the company.

After reviewing thousands of companies over dozens of years, we've found several crucial characteristics of quality management. Today, we'll size up the recent performance of PepsiCo's (NYSE: PEP) leadership.

How much skin do they have in the game?
Are PepsiCo CEO Indra Nooyi's interests aligned with shareholders? Here's how the PepsiCo CEO's ownership compares to that of other companies in the industry.

CEO, Company

Shares Owned

% of Shares Outstanding

Insider Ownership Market Value (in millions)

Indra Nooyi, PepsiCo

449,318

0.03%

$27

Muhtar Kent, Coca-Cola (NYSE: KO)

187,692

0.01%

$9

John Brock, Coca-Cola Enterprises (NYSE: CCE)

65,564

0.01%

$2

Larry Young, Dr Pepper Snapple Group (NYSE: DPS)

57,658

0.02%

$2

Source: Capital IQ, a division of Standard & Poor's. Shares are common stock equivalents only and do not include options, awards, and other forms of compensation.

Nooyi actually owns $29 million worth of PepsiCo, or 0.03% of shares outstanding. We Fools prefer CEOs who have higher ownership stakes in their businesses, since that better aligns their interests with shareholders'. However, while we think high insider ownership is a good sign, low insider ownership isn't necessarily a bad one. CEOs may be relatively new, or may have a low percent of shares outstanding, but a high total value of ownership.

How well are they using your money?
Return on equity can help investors determine how adeptly management gets the job done. This metric combines how well management is expanding profitability, managing assets, and using financial leverage, all in one ratio. While return on equity isn't foolproof -- managers can manipulate it with excessive leverage, for example -- it does an excellent job of suggesting how effective managers are, and how well they can generate high returns on investors' capital.

Here's a look at PepsiCo's recent return on equity:


Despite difficult economic conditions, PepsiCo managed to grow return on equity beyond its five-year average. Consistently increasing return on equity suggests that management is either adept at cutting costs and managing assets, or is moving the company into new high-return areas. An area worth noting is that PepsiCo manages to maintain stronger returns on equity versus rival Coca-Cola despite Coca-Cola's higher margins. Pepsi's done a fantastic job venturing out in other revenue streams outside of soda. This has led to revenue growth of nearly 10% annually over the past five years, with a corresponding 7% annual jump in earnings.

How productive are their workers?
Revenue per employee provides another way to gauge a CEO's effectiveness. If this metric is declining, the company might have a bloated organizational structure, or too many extra employees toiling away at new initiatives that just aren't working out. Either possibility would hint that management isn't effectively running the organization.



Source: Capital IQ, a division of Standard & Poor's.

As you can see, PepsiCo's revenue per employee has moved up over the last five years, but is down somewhat from 2008. Rising revenue per employee can suggest that management's getting better at controlling costs, or encouraging more productivity from its workers. To better see whether PepsiCo's management is excelling in this area, let's compare the company to its peer group once again:

Company

2005

2007

2009

Last Year's Revenue Per Employee vs. 5-Year Average

PepsiCo

$207

$213

$213

0%

Coca-Cola

$420

$319

$334

(5%)

Coca-Cola Enterprises

$257

$287

$309

4%

Dr Pepper Snapple Group

N/A

$285

$291

N/A

Source: Capital IQ, a division of Standard & Poor's. Dollar figures in thousands. N/A = not applicable.

PepsiCo's been growing its revenue per employee. Despite a slight drop last year, it appears the company is doing a good job of managing costs, though its absolute revenue per employee still trails its peer group.

In the end, management aims to return capital to shareholders, especially if the company can't adequately find new high-growth areas to invest in. So we're pleased to see that:

  • Dividends have increased by 14% annually over the past five years. The company's current dividend yield stands at 3%.
  • Its outstanding share count has dropped over the past five years. While CEOs are often tempted to retain key talent through lavish stock option awards, this tactic can dilute current shareholders if it's used excessively. If the company's stock isn't overvalued, buying back its own shares is a very tax-effective way to return capital to shareholders.

These are just a few of the factors we look for in a company's management. If you can find leaders who continually give shareholders high returns on their capital, and align their interests with yours, you've got a better chance to enjoy market-beating returns for the long haul.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Jeremy Phillips owns shares of no companies listed above. Coca-Cola is a Motley Fool Inside Value selection. Coca-Cola and PepsiCo are Motley Fool Income Investor selections. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Coca-Cola. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.