1 Simple Way to Identify Winning Stocks

Finding companies with great leaders is one way that might lead you to winning stocks. Identifying great leaders though, can be a subjective exercise. Luckily, we can get some hints from Thornton O’Glove, author of the 1987 investment book Quality of Earnings. With his years of experience as a securities analyst, O’Glove had a couple of tricks up his sleeve to share.

The curious incident

In his book, O’Glove encouraged investors to take a sceptical view of companies. He contended that the individual investor could do simple common sense checks to figure out if there were any possible problems in the horizon for a company. One of the simplest ways to evaluate management teams was similar to an old Sherlock Holmes story. Here’s a short snippet of the story:

Gregory (Scotland Yard detective): “Is there any other point to which you would wish to draw my attention?”

Sherlock Holmes: “To the curious incident of the dog in the night-time.”

Gregory: “The dog did nothing in the night-time.”

Sherlock Holmes: “That was the curious incident.”

The astute observation by Sherlock Holmes in this case was that there was a guard dog which did not bark at the sight of an intruder. Instead of the presence of evidence, it was the absence of a barking dog which led the legendary detective to suspect that something was amiss (hint: it turns out that the dog recognized the intruder).

The annual report that did not bark

In a similar vein, O’Glove encouraged investors to start with a simple act: Read the company chairman’s letter to shareholders in the annual report. Why? According to O’Glove, a 1984 survey of individual investors showed that more than half didn’t even do that.

That’s a shame.

The chairman’s letter to shareholders would typically include a summary of the company’s business condition as well as an outlook for the future. As Foolish investors, we may get to understand management’s point of view and how they thought about the year that just passed.

Then, there’s a next step we must do – and it is crucial.

O’Glove suggested to go a step further and read the entire annual report. This way, the individual investor can judge for themselves on whether or not management had omitted unflattering business developments. Said another way, the simple comparison between the chairman’s letter to shareholders and what actually transpired in the company can give you clues on how forthright the company’s management team is.

It is this omission of unflattering news that can be one simple way to evaluate companies’ management teams.

A local example

One positive example on the local front regarding honest management would be engineering company Boustead Singapore Limited (SGX: F9D). You can read more about the company here.  In the opening remarks of Boustead’s 2014 annual shareholder’s letter, Chief Executive Officer Wong Fong Fui was up-front on not being able to meet the previous year’s profit levels.

The candor of Boustead Singapore’s management team is also apparent during its quarterly conference calls. Boustead Singapore is involved with a number of different businesses and one of those involves the “design and build” of industrial real estate projects to suit the particular needs of the company’s clients.

During a recent conference call, Wong acknowledged the presence of new competition within the “design and build” space. He also added that although there have been new competition, the company has responded by moving into niche areas such as aerospace and biotechnology.

Ultimately, the actions of Boustead Singapore’s management team has brought benefits to long-term shareholders. From the start of January 2005 to 12 January 2015, shares of Boustead Singapore have generated a massive total return of 857%.

Foolish summary

Beating the Straits Time Index (SGX: ^STI) can be a daunting task on its own for the Foolish investor. If we have to constantly look over our shoulders at the management teams of the companies we own, our task in earning satisfying long-term returns becomes even harder. The choice of a good management team that is trustworthy ultimately lies with the private investor, so choose well. Read more about investing and get more investing tips and tricks, FREESign up here to The Motley Fool Singapore’s weekly investing newsletter, Take Stock Singapore.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.