3 Things to Look out for in a Company’s Management

Often, the difference between a good investment and a mediocre one boils down to how competent and reliable the management team of the company is. A management team that can allocate capital effectively, can react to the dynamic business environment and that has the shareholders’ interest at heart will usually provide good returns to shareholders.

Here are three things that investors should look out for when assessing a company’s management.

“Skin in the game”

The phrase “skin in the game” refers to a management team which owns shares in the company that it is running.

In theory, high-level executives who own shares in the company they manage are more likely to have shareholder interest at heart. It is, therefore, not uncommon to have executives compensated through share options as an incentive.

Furthermore, a manager who uses his or her money to purchase shares in the company he or she runs shows that he or she is even more confident in the company.

A good example is back in 2016 when DBS Group Holdings’ (SGX: D05) chief executive Piyush Gupta bought S$2.8 million worth of DBS shares on top of what he was awarded as part of his remuneration.

Sensible remuneration package

Investors can find out the remuneration packages of executives in the annual report of a company.

Previously, when analysing if a company was worth investing, I used to ignore this section of the annual report completely. I realised I was wrong to do that. The remuneration package of top executives can provide useful information to shareholders.

For one, it is important to note whether a single executive is being over-paid based on the company’s revenue or operating profits. As shareholders, we certainly do not want to see a company we own giving unfair remuneration to its top executives without justifiable reasons.

Second, bonuses should be based on long-term goals and improvement of the company’s return on invested capital and economic profits. On the contrary, executives who are paid based on share price targets may be incentivised to try to boost near-term share prices at the expense of a company’s long-term competitiveness.

Effective allocation of capital

Finally, investors should look out for management teams that can effectively utilise their available capital. Striking the right balance between using the money for growth through acquisitions, research or expansion, and paying shareholders through either dividends or share buybacks can make a whole lot of difference to the company’s long-term profitability.

Also, a company that can utilise debt prudently will be able to reward shareholders through higher returns on invested capital. At the same time, investors need to be wary of managers who are too aggressive with their acquisition policy or who over-leverage the company, saddling the company with unnecessary debt.

The Foolish bottom line

I cannot emphasise enough the importance of investing in companies that have a reliable and capable management team. It can easily be the difference between a long-term winner and an investment that lags the market.

These three qualities of a manager should provide investors with the stepping stone of identifying capable managers who can take the business forward and who have minority shareholders’ interest at heart.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has a recommendation on DBS Group Holdings Ltd. Motley Fool Singapore contributor Jeremy Chia owns shares in DBS Group Holdings Ltd.