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 Union Pacific's (NYSE: UNP) leadership.

How much skin do they have in the game?
Are Union Pacific CEO James Young's interests aligned with shareholders? Here's how his ownership compares with that of other companies in the industry.

CEO, Company

Shares Owned

% of Shares Outstanding

Insider Ownership Market Value (in millions)

James Young, Union Pacific

197,633

0.04%

$15

Charles Moorman, Norfolk Southern

259,470

0.07%

$14

Michael Ward, CSX

392,534

0.10%

$20

David Starling, Kansas City Southern

65,927

0.06%

$2

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.

Young actually owns $15 million worth of Union Pacific, or 0.04% 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. Young has been CEO of Union Pacific since Dec. 31, 2005, so while his tenure doesn't sit on the longer end, he's had some experience running the company.

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 Union Pacific's recent return on equity:


Despite difficult economic conditions, Union Pacific managed to grow return on equity beyond its five-year average. 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. While returns aren't out of this world in railroads, it is an attractive enough segment that Warren Buffett has poured his money into the industry.

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, Union Pacific's 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 Union Pacific's management is excelling in this area, 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

Union Pacific

$273

$325

$325

1%

Norfolk Southern (NYSE: NSC)

$281

$306

$279

(8%)

CSX (NYSE: CSX)

$245

$283

$300

6%

Kansas City Southern (NYSE: KSU)

$442

$269

$243

(19%)

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

Union Pacific's revenue per employee isn't just rising -- it's better than its combined peer group. That's quite an impressive feat.

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. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Fool has a disclosure policy.