Mark Lister

On Investing

Mark Lister: People at the top crucial in assessing company

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One of the most common questions I get asked by clients and investors is about the importance of company management. Of all the attributes and qualities that we look for when deciding whether to invest in a company, how important are the people in charge? Secondly, how exactly do we measure this?

There are many things that we look for when seeking out the best share investments: a strong balance sheet with debt levels under control, a competitive advantage, a dominant market position, high-quality assets, growth potential and strong operating cash flow. But all of these things can easily become meaningless if there isn't strong, trustworthy leadership.

All the comment and speculation around the recent resignation of Apple boss Steve Jobs highlights just how important strong leadership is in the eyes of investors and just how much impact management can have on the success, or failure, of a business. Jobs, one of the founders of Apple in the 1970s, left the company in the mid-1980s then returned in 1997 when the company wasn't in very good shape.

Today, it's one of the largest and most successful companies in the world, with growth momentum that seems unstoppable as products such as the iPhone and iPad change the way consumers use technology. He's played a key role in this turnaround in fortunes and his vision, leadership and ability to inspire a culture of innovation has been second-to-none.

The Apple share price immediately fell upon confirmation of his resignation, highlighting the concern investors have over how the company will fare in his absence. This is unsurprising given the influence he has had.

In this case, I expect Apple will continue to succeed. Jobs has built a strong team around him and, despite the fact he's been the main public face of the company, his legacy of innovation is likely to continue. His successor, Tim Cook, has had a long, successful career at Apple working closely with Jobs.

Similar speculation surrounds how Warren Buffett's company, Berkshire Hathaway, will manage when he's no longer fit enough to run it. The legendary investor is still CEO at 81 and his long-standing right-hand man, Charlie Munger, is 87.

In this part of the world, there are many leaders who've been critical to their companies' success. New Zealander Sir Ralph Norris retires as chief executive of Commonwealth Bank of Australia, the biggest of the big four Australian banks and parent of ASB, in November.

His replacement, fellow ex-pat New Zealander Ian Narev, has solid credentials and most investors seem relaxed about his departure, citing the team he's built around him.

In New Zealand, Don Braid from Mainfreight is regularly singled out as a strong leader. He's presided over the company during a period of phenomenal success and share price growth.

A unique culture among staff is a key reason for that accomplishment, something that begins at the top. We've also seen smaller companies like Charlie's and 42 Below achieve great outcomes for their shareholders on the back of a strong vision and a focused strategy, where many others have not succeeded. So the answer is a resounding yes, quality management is crucial and is top of the list when deciding which companies belong in our clients' portfolios.

However, the second part of the question, how to measure leadership quality, is much harder to answer.

A company's quantitative and financial factors are comparatively easy to see and measure. Debt levels, profit margins and historic growth levels can all be calculated, put into spreadsheets and some ratios and forecasts churned out. The value and skills of management are much less tangible and harder to assess, although arguably more important.

When it comes to assessing management, in many ways actions speak louder than words. We look for company leaders who are very focused on delivering shareholder returns, who know their businesses intimately, have a track record of success, and provide transparent and open communication with shareholders.

A disciplined, sensible approach to growth is important. Many companies have come unstuck by taking an overly aggressive approach to getting larger, or by buying good assets but paying too much and getting themselves heavily in debt in the process. A company that makes large transformational decisions, such as a significant acquisition, isn't necessarily doing the wrong thing, but it does require added scrutiny.

Australian company Transpacific Industries suffered from trying to grow too big too fast. It acquired NZX-listed Waste Management some years ago, followed by fellow competitor Cleanaway soon after that. While all the businesses were good-quality, Transpacific took on too much debt and such rapid growth by acquisition proved overly ambitious.

Wrightson faltered in a similar way a few years ago, first acquiring Williams & Kettle, then merging with Pyne Gould Guinness. The company had a vision that made sense, but its approach was too aggressive. Integrating the different operations proved more difficult than it expected and the strategy failed.

Many successful companies have executive teams that have been very stable for a long time. While a fresh approach can revitalise a business, continuity is also important, so we look for companies where the managers have been there for a reasonable length of time.

A strong bench is also important and many good managers will surround themselves with an equally competent team. A revolving door of executives is an alarm bell.

We also look for management that has a history of doing what it says it will do and backing up financial forecasts with results. All businesses are influenced by a range of factors and many of these are unpredictable, such as oil prices, currencies and levels of customer demand. But questions have to be asked of those management teams that regularly miss their forecasts.

Another good sign is when CEOs and managers have their own money in the business. While management and shareholder interests should be aligned as part of a CEO's remuneration package, having skin in the game further ensures that management shares successes and failures with shareholders.

When you invest in a company, you are investing in the people running it. Regardless of how good the assets or prospects of a business are, it can fail to deliver if managed poorly.

But identifying those CEOs, directors and teams we can trust to deliver results is more difficult and subjective than interpreting the cash-flow statement in an annual report. It's vital to meet company management regularly, discuss the business and ensure its direction can be understood and endorsed.

The shares I consider best-of-breed in the local market include the likes of Port of Tauranga, Ryman Healthcare, Hellaby Holdings, Freightways, TrustPower, Property for Industry and Fletcher Building, for their quality and depth of management.

The integrity, strategic vision and leadership of a company are all essential factors in its success and, although they may sometimes be difficult to quantify, you should give them high priority when deciding where to put your money.

* Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile at www.craigsip.com. This column is general in nature and should not be regarded as personalised investment advice.

- NZ Herald

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