Three Qualities to Look out for in a Management Team

One of the most important aspects of a business that Warren Buffett looks for is a management team that he trusts. He once said, “When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever.”

Having said that, it may sometimes be challenging for retail investors to judge the qualities of a company’s management.

Fortunately, Robert Hagstrom, in his book, The Warren Buffett Way, explains three easy ways to identify a good management team.

1. Management that makes rational decisions

The easiest way to identify a rational management team is whether they allocate capital intelligently. This is simply because the successful allocation of capital can help unlock shareholder value in the future.

Ironically, one of the best examples of a management team that allocates capital rationally is the team made up of Warren Buffett and his partner Charlie Munger. Their underlying business of insurance provides them with a huge amount of float that they can invest with. With this capital, they have managed to grow their business at market beating returns of 19.8% annually. In turn, this has led to shareholders of Warren Buffett’s company reaping the rewards as well.

Besides investing, management can also choose other ways to use their capital. These include giving them back to shareholders via dividends, share buybacks, or through expansion or acquisitions. A management team must, therefore, weigh out each option and decide which best benefits shareholders’ interests.

2. Management that is honest to shareholders

The most important thing to look out for is an honest and candid management team that will speak the truth to its shareholders. Unfortunately, in recent times, this is an exceedingly rare quality to find in managers.

Many management teams, all too frequently, try to beef up their firms’ financials by using unconventional metrics that spice up its earnings. They are also prone to being overly optimistic about the prospects of their company and may give shareholders a skewed outlook of their business. All this is done in a bid to retain shareholder loyalty and to increase the company’s share price.

This should be a big red flag for investors. A company with a management team that is not honest and has a tendency to exaggerate may not be a good investment, regardless of the prospects of the business.

3. Management that is willing to go against the grain

Warren Buffett said that there was a tendency for corporate management to imitate the behaviour of other managers. He called this “the institutional imperative”.

He noticed that this led to irrational decisions as managers try to copy others within their trade. This resulted in unnecessary acquisitions and other poor business decisions.

Therefore, if we are to find a good management team, we should look out for managers who are capable of going against the grain. They should be able to make difficult decisions based on sound strategic thinking, rather than simply following other managers that have gone before them.

The Foolish bottom line

Finding a capable and honest management team is as important as looking out for a company that has a good business model and solid financials. However, as retail investors, we may sometimes have little clue on how to assess whether a management team is capable and trustworthy. Hopefully, these three fundamentals will give us an idea of where to begin.

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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 Jeremy Chia doesn't own shares in any companies mentioned.