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 for 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, 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 E*TRADE Financial's (Nasdaq: ETFC) leadership.

How much skin do they have in the game?
Are E*TRADE Financial CEO Steven Freiberg's interests aligned with shareholders? Here's how his ownership compares to his peer group.

CEO, Company

Shares Owned

% of Shares Outstanding

Insider Ownership Market Value (in millions)

Steven Freiberg, E*TRADE Financial

57,143

0.03%

$1

Walter Bettinger, Charles Schwab

468,168

0.04%

$7

Fredric Tomczyk, TD AMERITRADE

656,409

0.11%

$10

Ronald Kruszewski, Stifel Financial

564,654

1.58%

$26

David Fisher, optionsXpress Holdings

83,168

0.14%

$1

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

Steven Freiberg actually owns $1 million worth of E*TRADE Financial, 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 E*TRADE Financial's recent return on equity:


E*TRADE Financial'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 past five years.

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, E*TRADE Financial's revenue per employee has moved below its five-year average. This might mean that the company's hiring too many people, or spending too much. To better see whether E*TRADE Financial's cost controls are actually deficient, 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

E*TRADE Financial

$474

($173)

$141

(26%)

Charles Schwab (NYSE: SCHW)

$259

$375

$336

(1%)

TD AMERITRADE Holding (Nasdaq: AMTD)

$488

$530

$456

(6%)

Stifel Financial (NYSE: SF)

$159

$269

$246

12%

optionsXpress Holdings (Nasdaq: OXPS)

$827

$932

$552

(31%)

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

E*TRADE Financial's trailing its peer group in this category over the past five years. Shareholders should keep a wary eye on this red flag in the coming quarters.

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 does not own shares of the companies mentioned. optionsXpress Holdings and Charles Schwab are Motley Fool Stock Advisor picks. MF Global Holdings is a Motley Fool Global Gains choice. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.