We've often advised investors to look at the quality of management when evaluating a company as a possible investment. (We've also pointed out that another good sign is when a company doesn't lavish its CEO with riches.) Of course, it's not always easy to judge the quality of a company's executives. That's one reason our Motley Fool analysts are often visiting companies or speaking with corporate bigwigs in other ways.
But you typically can't just walk up to a corporate office and ask to chat with the CEO. So what can you do? Well, one sign of effective management is, simply, solid results. If a company's revenue and earnings are all over the place, or if they're falling, there's a good chance that management doesn't have things under control. If they're growing steadily, that's a green flag.
Smooth earnings can be good, too, but the Bernie Madoff debacle offers us a warning to be wary when growth is too smooth. In good market environments and bad, Madoff's results didn't waver very much. The stock market has gone up over many decades, but along a jagged line, not a steady slope.
You should also look for candor in a CEO's annual letters to his or her shareholders. According to University of Michigan Business School professor Fiona Lee, when a company's leaders take responsibility for a lackluster performance, its stock will tend to rise in the coming year. "Shareholders have more favorable impressions of companies if their managers accept blame for negative performance," Lee explains. She also suggests that taking accountability suggests that the company is in control of its destiny, and not just being tossed back and forth on the market's waves.
A study last year by Rittenhouse Rankings rated companies based on their annual reports. Wells Fargo (NYSE:WFC), Novartis (NYSE:NVS), and Target (NYSE:TGT) got good marks, but those that fared poorly included Boeing (NYSE:BA), Coca-Cola (NYSE:KO), and Estee Lauder (NYSE:EL).
So as you study companies, check to see whether they're blaming poor performance on their own shortcomings -- and whether they have plans to fix those problems -- or whether they're pointing to external factors out of their control, such as the poor economy. This year, the economy will surely affect many companies, but so will their own strategies and executions.
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