The stock market is a risky place. But there are ways to minimize your potential risks and maximize your potential gains. Today I'd like to share one paradigm that is absolutely crucial to our analysis at Motley Fool Hidden Gems: quality of management.
But first, the facts and figures
I believe that quality of management is a strong indicator of a great investment opportunity. Unfortunately, quality of management can be difficult to quantify. One way for investors to try, however, is to score the management team at any prospective investment based on these three criteria:
A chairman, CEO, and board of directors that possess all three of these core traits are signs that the company is well-positioned for growth. This doesn't mean that the stock is a surefire gainer, but at least it's pointing in the right direction.
He's got game
One knock on small companies -- the area of the market that we specialize in at Hidden Gems -- is that they can't attract the best managerial talent. Consider, for example, that George Buckley wasn't going to leave Brunswick
All three of these men are talented executives -- and a quick read of their biographies reveals them as such. It's unlikely that any small company could afford them at their current going rates.
Small companies can overcome this hurdle by filling their boards with experienced leaders. That, however, can also prove difficult. For example, just compare the board at PepsiCo with the board at Hansen Natural. While Pepsi receives counsel from former AT&T chief Robert Allen, Novartis
Signs of a 240-bagger
This hasn't, though, precluded Hansen from absolutely smashing the market over the past 10 years to the tune of 23,000%. And while it would be difficult to judge the skill and experience of Hansen's board based on their biographies, a closer look would reveal that they possess commitment and tenure in spades.
As a group, insiders at Hansen own nearly 40% of outstanding shares. That's a meaningful indicator that the leadership at Hansen is absolutely committed to the success of the business. What's more, five of the company's seven board members have been in place since the early 1990s. And why not? The company has done quite well during their tenure.
Those are two ways to score commitment and tenure. Others include a propensity for conservative pay packages, a disinterest in the short-term machinations of the stock market, and a communications strategy that is more substance than hype.
The Foolish bottom line
Taken together, investing in quality management teams is one way to mitigate risk and maximize reward in the stock market. You can find them by focusing on skill, commitment, and tenure. But remember: All three must be present. The most experienced, knowledgeable CEO in the world won't make a dime's worth of difference if -- like the average CEO -- he doesn't stick around for any meaningful length of time.
Quality management isn't the only hallmark of a great investment, however. So if you'd like to learn what else we look for at Motley Fool Hidden Gems and what specific stocks we're recommending for new money now, click here to join our service free for 30 days. Our picks are beating the market by 13 percentage points, and there's absolutely no obligation to subscribe.
This article was originally published on Sept. 22, 2006. It has been updated.