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 Exelon's (NYSE: EXC) leadership.

How much skin do they have in the game?
Are Exelon CEO John Rowe's interests aligned with shareholders? Here's how the Exelon 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)

John Rowe, Exelon

308,371

0.05%

$12

David Ratcliffe, Southern

18,882

0.00%

$1

James Rogers, Duke Energy

1,852,031

0.14%

$32

Lewis Hay, NextEra Energy

440,052

0.11%

$23

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.

Rowe actually owns $12 million worth of Exelon, or 0.05% 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 Exelon's recent return on equity:


Exelon's current return on equity falls below levels seen in previous years. 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. In recent years, net income has been flat while the company's equity line has been increasing. The combination has resulted in declining ROE, management will need to focus on bottom line gains if it wants to see meaningful ROE gains in coming 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, Exelon'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 Exelon'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

Exelon

$893

$1,063

$896

(5%)

Southern (NYSE: SO)

$530

$574

$603

4%

Duke Energy (NYSE: DUK)

$333

$699

$667

19%

NextEra Energy (NYSE: NEE)

$1,161

$1,063

$1,016

(8%)

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

Exelon's is trending lower in this category over the past five years, while Southern and Duke have trended up. Shareholders should keep a wary eye on this red flag in the coming quarters.

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 6.9% annually over the past five years. The company's current dividend yield stands at 5.2%.
  • 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. Exelon is a Motley Fool Inside Value recommendation. Duke Energy and Southern are Motley Fool Income Investor selections. The Fool owns shares of and has written covered calls on NextEra Energy. The Fool owns shares of Exelon. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.