The One Thing You Must Know About Sonus Networks

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 ways to evaluate 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 Sonus Networks' (Nasdaq: SONS) leadership.

How much skin do they have in the game?
Are Sonus Networks CEO Richard Nottenburg's interests aligned with shareholders? Here's how the CEO's ownership compares to that of his peers in the communications equipment industry.

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

Nottenburg actually owns $5 million worth of Sonus Networks, or 0.59% 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 percentage 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 Sonus Networks' recent return on equity:

In the face of difficult economic conditions, Sonus Networks managed to grow return on equity beyond its five-year average, although it's still well below the elevated levels seen in 2006. 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.

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, Sonus Networks' 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 Sonus Networks' cost controls are actually deficient, let's compare the company to its peer group once again:

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

Sonus Networks is trailing its peer group in this category over the past five years. Shareholders should keep an 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.