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 Colgate-Palmolive's (NYSE: CL) leadership.

How much skin do they have in the game?
Are Colgate-Palmolive CEO Ian Cook's interests aligned with shareholders? Here's how the Colgate-Palmolive 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)

Ian Cook, Colgate-Palmolive

492,536

0.10%

$37

Thomas Falk, Kimberly Clark (NYSE: KMB)

381,644

0.09%

$25

Robert McDonald, Procter & Gamble (NYSE: PG)

181,842

0.01%

$11

Donald Knauss, Clorox (NYSE: CLX)

91,855

0.07%

$6

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.

Cook actually owns $37 million worth of Colgate-Palmolive, or 0.10% 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. In Cook's case, he's been CEO of Colgate-Palmolive since 2007.

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 Colgate-Palmolive's recent return on equity:


Colgate-Palmolive's current return on equity falls below its five-year average. While recent economic conditions have been challenging, declining return on equity shows either that management hasn't been able to control costs and manage assets, or that it's failed to move into higher-return businesses over the last five years. With an ROE of around 100%, you might be tempted to think Colgate-Palmolive is one of the most profitable companies on the planet. However, the company continually builds up its Treasury Stock through share buybacks, which reduce the amount of equity on its balance sheet. That's not necessarily a bad action, but it serves to inflate the company's return on equity.

Judging management another way, through its net income margin, Colgate-Palmolive has performed solidly in the past five years. Net income margins have moved from 11.9% in 2005 to 13.9% in the past twelve months.

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, Colgate-Palmolive's revenue per employee has moved above its five-year average. 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 Colgate-Palmolive'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

Colgate-Palmolive

$318

$383

$402

7%

Kimberly Clark

$279

$345

$341

4%

Procter & Gamble

$516

$542

$568

11%

Clorox

$577

$621

$657

4%

Source: Capital IQ, a division of Standard & Poor's. Dollar figures in thousands.

Colgate-Palmolive's revenue per employee isn't just rising – the rate of improvement is near the top of its peer group. That's quite an impressive feat.

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 12.9% annually over the last five years. The company's current dividend yield stands at 2.8%.
  • 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.

Jeremy Phillips owns shares of no companies listed above. Clorox, Kimberly Clark, and Procter & Gamble are Motley Fool Income Investor recommendations. The Fool owns shares of and has written covered calls on Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. 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. The Motley Fool has a disclosure policy.