Tangible facts or intangible facts -- which would you prefer? Tangible facts for stocks are the numbers we see every day -- EPS, growth rates, ratios, etc. Investors often prefer them because they are easy to calculate and analyze. But in the investing world, the word "easy" can often be replaced with "misleading." The intangible facts tell us how a company generated its numbers, and what kind of numbers it can generate in the future. Following the intangibles helps keep investors from falling into the number traps waiting to be triggered.
May I speak to the manager?
One critical intangible to keep track of is the quality of the management team. Although there are critical flaws there quite often, it really isn't discussed as often as it should be. Perhaps it's because there isn't anything like a P/E ratio to measure it, or maybe it's because we find bad news reported more often than the good news. Unfortunately, I think it often comes down to the fact that most shareholders do not view themselves as actual owners of a business. Whether an executive team has the skills to unlock unrealized business potential or it's in the process of destroying shareholder value is something all owner-investors should be aware of. After all, it can give you a huge advantage over other investors -- something that you can never have enough of.
Because management controls how the business is run, there are many characteristics you should look for. A few important ones include:
- Experience and a history of success
- Significant ownership
- No conflicts of interest
- Trustworthy
The first three take just a few minutes to learn about by searching the Web or reading a company's Securities and Exchange Commission filings, especially the footnotes for conflicts of interest or pending lawsuits. The last one takes a lot more time and effort, but is well worth it if you consider yourself an owner-investor. It helps me to think of management as a car salesman or saleswoman. If this management team were selling me a car, would it sound like it wants to get cars off the lot and make a buck, or does it want me to be really happy with the entire experience so that I will tell others about that dealership? The best place to start this process is by reading past letters to shareholders and by listening to the annual and quarterly report conference calls. If you're lucky, a company will provide transcripts on its investor relations website. If not, get out a pen and paper -- or open your favorite word processor -- and take good notes.
Not just a fantasy
The importance of management can be emphasized in an analogy to fantasy sports. In fantasy sports, you own a team of players similar to the "team" of individual stocks in your investing portfolio. At the end of the season, the total statistics your players generate are added up, and bragging rights go to the team with the best overall stats.
Initially, I focus my research on the statistics, as I do with the financial statements of a company. But a player's personality is vitally important to the final value I place on that player. For example, Terrell Owens is arguably the best wide receiver in the National Football League, capable of carrying a fantasy team to a championship. But his history of confrontations with teammates and coaches makes him a high-risk, high-reward player. In other words, you'd better be prepared if things don't go right -- and last year, things definitely did not. He was banished several weeks into the season. Thankfully, I had prepared for that scenario and was still able to achieve my main goal of making the playoffs and putting myself in a position to win (although I didn't win the title this time).
It's all about the "O"wners
If we think of a player as a stock, we can view the personality as the management team. Athletes often behave very much like management teams. Some take their talents or position for granted and end up being inconsistent performers; others work hard enough to be excellent players, even if they don't have as much talent. Of course, there are the Terrell Owens management teams to consider -- the Enrons of the world. These people are often more interested in their own riches and glory, and could care less about the real owners of the company. But management teams worth avoiding aren't always doing something illegal. Besides making bad business decisions, they can be guilty of handing out excessive options and bonuses, trying to appease analysts and match estimates to keep the stock price elevated while they dump shares, or other activities that end up destroying shareholder value.
I think a perfect example of a manager who's not entirely focused on creating value is CEO Patrick Byrne at Overstock.com (NASDAQ:OSTK). While I believe that Byrne is very intelligent -- and quite entertaining, to boot -- it just isn't clear to me that he is completely focused on the long-term future of the company. With a powerful brand that is helping drive huge revenue increases, Byrne's company has the potential to be great. And with a price-to-sales ratio of just 0.54, Overstock has value, too. Based solely on the numbers, it looks like a winner to me. It's also nice to see someone trying to actually do something about the problem of naked short selling. Alas, the key question is this: What good is he doing for the owners? When a manager is distracted by tangential concerns, that results in less time for contemplating the best ways to grow the business and build more shareholder value. Owners should require this from their leaders.
You're a great big superstar
I wouldn't want to end this piece without discussing some of the recent stars in investing, though. These are the players with the most potential and the work ethic to put it to good use. Companies such as Middleby (NASDAQ:MIDD) and Select Comfort (NASDAQ:SCSS) come to mind.
The futures of both of these companies looked pretty dismal just a few years ago, but that is no longer the case. The CEOs have guided their corporate ships through some rough waters. A decent amount of inside ownership means crew members have just as much interest in the company's success as outside owners. Finally, quarter after quarter, the management teams have delivered on promises to create shareholder value. Taken together, these things build up investors' confidence and trust in management and the decisions its makes. At this point, something will have to rock the boat pretty hard before most owners will jump from these ships.
A devoted leadership team is something that Tom Gardner uses in his search for the next mega-baggers in his Motley FoolHidden Gems newsletter. It's no accident that leadership is No. 1 on his list of traits, nor that he has recommended Middleby and Select Comfort to subscribers multiple times.
Fool contributor John Bluis thinks the only way to own mega-baggers is to be an owner-investor. He also thinks you should know that he is an owner-investor of Select Comfort, but has no financial interest in any other stock mentioned in this article. Overstock is a Rule Breakers recommendation. The Motley Foolwants you to know that.
