When evaluating companies as candidates for an investment portfolio, we tend to study past results, such as growth rates, profit margins and their trends, and so on. It's critical to think about a company's future, though, because a company without a promising one is unlikely to be a great investment.
One key way to get insights on how well a company might perform in the future is to examine the qualities of its top management -- the people who will be guiding the enterprise forward.
We asked three Fools what they view as the most important attributes of an effective CEO. Here's what they said.
Brian Stoffel: Investing all boils down to this: You're putting your own hard-earned money behind a belief in a group of people. Those people are the members of the management team of the company you want to own a small slice of. We might like to believe otherwise, but -- as we are all human -- we respond strongly and consistently to incentives. Far too often, CEOs of companies are incentivized to pump up short-term profits, often at the expense of long-term viability and financial health of company and its other stakeholders.
That's why "skin in the game" matters. As Nassim Taleb pointed out in his brilliant book Antifragile, today's leaders don't have enough skin in the game. While in the old days the bridge-maker was forced to live beneath the bridge he designed (what better way for the community to know it would be safe?!), the financial company CEOs whose institutions played such a large role in causing the Great Recession had very little downside exposure to the consequences of their decisions.
In my family's own retirement portfolio, one company accounts for a whopping 16% of our holdings: Amazon.com. We've owned the stock since the Great Recession, and one of the reasons we've never parted with it -- even though it continually posts unprofitable quarters as it pursues its mission of being the most customer-centric company in the world -- is because of its founder and CEO, Jeff Bezos.
Bezos has never wavered in his resolve to play the long game, and he's backed it up by putting his own financial future on the line. Currently, he owns 84 million shares of Amazon -- or about 18% of the company. Those shares are worth well over $45 billion. That's significant skin in the game, and I think investors would be well-served to seek other CEOs who put their money where their mouth is.
Brian Feroldi: One tool that I use to measure the effectiveness of CEOs is to look at what kind of reviews they get from their own employees.
Just a few years ago, getting access to that kind of data would have been nearly impossible, but it's easy nowadays thanks to websites such as Glassdoor.com. That site allows for employees to post reviews of the companies they work for and to register their approval (or lack thereof) of their CEOs anonymously, which tends to make people willing to share their true feelings.
One CEO who has garnered a lot of love from his employees is Omar Ishrak of medical device giant Medtronic. Ishrak has been reviewed by more than 484 of his current and former employees, and an amazing 93% of them approve of the job that he is doing. That's a terrific rating, especially when considering Medtronic's size, and it makes him one of the most highly rated CEOs of a large company out there. That should make Medtronic's investors feel good about their leader, as it's hard to win such great reviews from so many employees without doing something right.
Glassdoor.com isn't a perfect tool, as the ratings for small companies with just a handful of reviews can be rendered useless by a disgruntled (or overly enamored) employee or two, but the site can help measure just how effective many CEOs are at leading their organizations.
Selena Maranjian: One key measure of an effective CEO is candor. When companies face challenges, you don't want a CEO who is denying the status quo, whitewashing problems, or telling shareholders and investors that all is well. It may be hard to be frank and to admit mistakes or problems, but doing so is a sign of integrity, and can boost the public's faith in management.
The folks at Rittenhouse Rankings have been studying this topic for many years now, and along with their annual report released last summer, they noted that "Top-ranked companies in the 2014 Rittenhouse Rankings Candor Survey outperformed the S&P 500 by an average of 7.4% between Q2 2014 and Q2 2015. Over the past five years, top-quartile companies have outperformed the market by an average of 9.5%." Top-rated companies included JetBlue, Honeywell, Sherwin-Williams, Alphabet, and Costco, while the bottom-rankers included AIG, Bank of America, and McDonald's.
A good example of CEO candor would be Chipotle Mexican Grill's Steve Ells, who took out full-page newspaper ads after a food-poisoning scare, owning it: "...recent incidents, an E. coli outbreak that sickened 52 people and a norovirus outbreak that sickened approximately 140 people at a single Chipotle restaurant in Boston, have shown us that we need to do better, much better."
Berkshire Hathaway's Warren Buffett, meanwhile, has long been known for his candor, saying in his 1998 letter to shareholders that, "The portfolio actions I took in 1998 actually decreased our gain for the year. In particular, my decision to sell McDonald's was a very big mistake. Overall, you would have been better off last year if I had regularly snuck off to the movies during market hours." When you assess a portfolio candidate, assess its CEO's candor, as well.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Brian Feroldi owns shares of Alphabet (A shares), Alphabet (C shares), Amazon.com, and Chipotle Mexican Grill. Brian Stoffel owns shares of Alphabet (A shares), Alphabet (C shares), Amazon.com, and Chipotle Mexican Grill. Selena Maranjian owns shares of Alphabet (A shares), Alphabet (C shares), Amazon.com, Chipotle Mexican Grill, Costco Wholesale, and Medtronic. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon.com, Chipotle Mexican Grill, and Costco Wholesale. The Motley Fool owns shares of Medtronic. The Motley Fool recommends Bank of America and Sherwin-Williams. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.