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 in 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 United Technologies' (NYSE: UTX) leadership.

How much skin do they have in the game?
Are United Technologies CEO Louis Chenevert's interests aligned with shareholders? Here's how Chenevert's ownership compares with that of other CEOs in the industry.

CEO, Company

Shares Owned

% of Shares Outstanding

Insider Ownership Market Value (in millions)

Louis Chenevert, United Technologies

290,594

0.03%

$20

W. James McNerney, Boeing

238,264

0.03%

$15

David Cote, Honeywell International

69,516

0.01%

$3

Bob Stevens, Lockheed Martin

1,090,898

0.30%

$80

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

Chenevert actually owns $20 million worth of United Technologies, or 0.03% of shares outstanding. We Fools prefer CEOs who have higher ownership stakes in their businesses, because 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 United Technologies' recent return on equity:


United Technologies' 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 has failed to move into higher-return businesses over the past five years. In United Technologies' case, it faces strong headwinds with the crimp on defense spending across the next several years. Its diversified nature and focus on necessary infrastructure gives the company some insulation, but managing to grow return on equity across the next several years will be a difficult task for management.

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, United Technologies' 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 United Technologies' management is excelling in this area, let's compare the company with its peer group once again:

Company

2005

2007

2009

Last Year's Revenue Per Employee vs. 5-Year Average

United Technologies

$192

$245

$256

8%

Boeing (NYSE: BA)

$350

$417

$435

10%

Honeywell International (NYSE: HON)

$238

$284

$253

(5%)

Lockheed Martin (NYSE: LMT)

$276

$299

$323

10%

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

United Technologies' revenue per employee isn't just rising -- it's better than its combined 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 15.4% annually. The company's dividend yield is 2.5%.
  • Its outstanding share count has dropped over the past five years. While CEOs are often tempted to keep 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 doesn't own shares of companies listed above. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.