Course 207: Weighing Management Quality
Why Management Matters
In this course
1 Introduction
2 Why Management Matters
3 Management Structure
4 Buying a Business
5 20 Questions
6 The Bottom Line

In his groundbreaking work Common Stocks and Uncommon Profits, Philip Fisher argues that because company managers are much closer to a company's assets than stockholders, they wield considerable day-to-day influence over the arrangement and disposition of the company's affairs. (For more on Fisher, see Lesson 505.) According to Fisher, "Without breaking any laws, the number of ways in which those in control can benefit themselves and their families at the expense of the ordinary stockholders is almost infinite."

Fisher suggests that investors should accumulate as much background information on companies and their managers as possible by talking to people in the industry. He refers to the process as gathering "scuttlebutt." Visiting management in person, and interviewing line managers, competitors, customers, and suppliers are most stock analysts' preferred means for gathering such information, and the impressions they garner during these visits can have a strong, yet subtle impact on their view of the company's prospects. This type of research is typically not realistic for nonprofessional investors with limited time, but there are still things you can do to get a sense of the quality of a company's management.

Ultimately, it boils down to trust: As an investor, can you trust this management team to develop and execute the right business plan and perform their duties in your best interest?

Investors can easily familiarize themselves with the backgrounds and qualifications of the managers of the companies they invest in by checking their biographies on company Web sites or in the annual proxy statements sent to shareholders (and filed with theSEC as Schedule DEF 14a). Part of answering the question, "Can I trust this team?" certainly hinges on basic information like, "Is the team qualified?" But often enough in corporate America, managers have grown up with a company, and their resumes won't say much about what they've done recently, and they won't tell you much about whether to trust these individuals with your money.

We believe that in the grand scheme, people respond to the incentives they are given or set for themselves. In some ways, this represents the kernel of the American Dream: Regardless of your background, if you prove yourself and work hard, you can do anything. The promise of financial reward accompanies most versions of the American Dream we've heard of. This is the angle from which we here at Morningstar approach the question about trusting management. We assume the team is qualified (whether by pedigree, education, or hard knocks), but we question the motivation and reward system that the team (including the board of directors) has put in place and by which they measure their own performance.

Next: Management Structure >>

Print Lesson |Feedback | Digg! digg it
Learn how to invest like a pro with Morningstar’s Investment Workbooks (John Wiley & Sons, 2004, 2005), available at online bookstores.
Copyright 2015 Morningstar, Inc. All rights reserved. Please read our Privacy Policy.
If you have questions or comments please contact Morningstar.