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Summary A weak market environment reveals weaknesses in companies that would go unnoticed in good or moderate times. Management excellence becomes critically important as economic stresses emerge. Excellence is achieved by integrity in relationships with three key constituencies. Only when the tide goes out do you discover who’s been swimming naked. –Warren Buffett A weak market environment reveals weaknesses in companies that would go unnoticed in good or moderate times. –David Merkel Would you rather invest your hard earned dollars with the best-run companies in the world or the worst? The answer may seem obvious but there are millions of people have their money invested with managers who are plainly bad. I have been one of them in the past and perhaps you have been as well. Over the past 6 years investors haven’t had to give quality of management much thought, as rising stock prices and profits have allowed us to overlook mistakes and bad decisions. This happy time has already begun to change. Regardless of what the economic future holds, it’s undeniable that stresses have developed in the global economic system. Quality of management is about to become a much more important factor in company fortunes. For years it is been reasonably easy for management to keep shareholders happy with regularly increasing stock prices and higher profits. As the quotes above suggest, in times of stress management becomes critically important. Quality of management could soon become the differentiator between success and failure — even life and death — on the corporate level. Identifying Excellence In Management With widespread improvements in common metrics like profits and stock prices, how do we differentiate? How do we tell where the truly excellent (and truly bad) management is? A more comprehensive approach is required. The vast majority of managements will fall in the middle range of quality, and time is best spent identifying the very best and worst. After all, these are the managements that will produce the most consequences for us as investors. In addition, sustained excellence does not flow from a single great leader. No one can deny the importance of Steve Jobs at Apple, Alan Mulally at Ford, or Jack Welch at General Electric, but great leaders aren’t forever and their performance is not often repeated by their successors. In fact, it is dangerous to trust your money to a single individual no matter how talented, as Apple after Jobs’s first departure and GE after Welch demonstrated. True excellence is a culture that endures over generations of executives. Superior management is identified by integrity in relationships with its three main constituencies: customers, shareholders, and employees. All three of these “pillars of excellence” are essential – none can be ignored. In times of stress deficiencies in any one will be magnified and threaten the success of the enterprise. Excellence in each area, however, will support the others and the entire company. They provide a complete and robust assessment of management when added to standard measures like return on equity, share prices and dividend growth. The Three Pillars Customers Excellence in the customer relationship starts with high quality products and services that are valued by customers. Well-known examples are Nike, Tesla, Google, Tiffany, Johnson & Johnson, Caterpillar, Deere, Union Pacific, Apple, and Boeing. A different example is Family Dollar (NYSE: FDO ) which, although the products it sells are ordinary, has a combination of selection and price that fills an important customer need. Another aspect is customer service, and there are many studies of the best and worst companies in this regard. A recent study by 24/7 Wall Street rated these at the top. Best: Amazon (NASDAQ: AMZN ) Chick-fil-a Apple (NASDAQ: AAPL ) Marriott (NASDAQ: MAR ) Kroger (NYSE: KR ) Fedex (NYSE: FDX ) Trader Joes Sony (NYSE: SNE ) Samsung ( OTC:SSNLF ) UPS (NYSE: UPS ) And these rated worst: Comcast (NASDAQ: CMCSA ) DirectTV (NASDAQ: DTV ) Bank of America (NYSE: BAM ) Dish Network (NASDAQ: DISH ) AT&T (NYSE: T ) AOL (NYSE: AOL ) Verizon (NYSE: VZ ) T-Mobile (NYSE: TMUS ) Wells Fargo (NYSE: WF ) Walmart (NYSE: WMT ) Obviously, customer service is more challenging in some industries than others. The survey recognizes this and has two sets of rankings: from all executives and experts within each industry. Employees Who better to say which are the best companies to work for than the employees themselves? Fortune and the Great Place To Work Institute have been doing comprehensive surveys of employees for 25 years produce an annual list of the 100 Best Places to Work . Their model is based on five dimensions: Credibility, Respect, Fairness, Pride and Camaraderie. The top ten public companies (fourteen of the top twenty-four are private) in 2015 are: Google (NASDAQ: GOOG ) Salesforce (NYSE: CRM ) Genentech ( OTCQX:RHHBY ) Camden Property Trust (NYSE: CPT ) Klimpton Hotels and Restaurants (NYSE: IHG ) NuStar Energy (NYSE: NS ) Stryker (NYSE: SYK ) Ultimate Software (NASDAQ: ULTI ) Workday (NYSE: WDAY ) Twitter (NYSE: TWTR ) In times of economic distress investors want to a part owner in companies with employees who support and have confidence in management, and are invested in the company’s success. This is achieved when management does the same for their employees. Shareholders This is perhaps the most complex of the three “pillars” of excellence. Continuing the survey theme, Fortune and the Hay Group compile an annual list of the most admired companies in America. There are some methodological issues with and it includes only the largest companies, but healthy financials and stock performance are major factors so it is useful in this regard. The full list is here . The top ten “All Stars” for 2015 are: Apple Google Berkshire Hathaway ( BRK ) Amazon Starbucks (NASDAQ: SBUX ) Walt Disney (NYSE: DIS ) Southwest Airlines (NYSE: LUV ) American Express (NYSE: AXP ) General Electric (NYSE: GE ) Coca Cola ( K O) Institutional Shareholder Services has been assessing corporate governance for over 30 years. They examine over 200 factors to rate boards of directors in four areas: board structure shareholder rights compensation audit risk & oversight It addresses important questions like Is the board of directors independent or controlled by the chairman? Is compensated reasonable or detrimental to shareholders? Is there overboarding — do they sit on so many boards that they have excessive time commitments and may be unable to fulfill their duties? The rankings are interesting. Apple scores near the top in three of the four areas, but is in the bottom decile in compensation. Companies like Google and Groupon (GRP) that have dual stock classes generally rate poorly. Shareholder input An important aspect of this pillar comes from the shareholders themselves. Shareholders are very vocal on sites like Yahoo and Seeking Alpha about their relationship with management. When unhappiness is expressed, it can be an important sign that management is not aligned with shareholder interests. Dissatisfaction can occur whenever a company is underperforming, so it’s important to distinguish between general grumbling and more specific concerns. Questions about things like management compensation, risk, dilution, and conflicts of interest merit attention. Recent examples of serious red flags include: Prospect Capital (NASDAQ: PSEC ): Many investors have criticized management compensation, honesty about nonperforming assets, and other issues. This comment is typical: Leopards don’t lose their spots. Those of us who owned in the 10 dollar range remember Mgt. sold more shares, raised their mgt. fees, then cut the dividend. Leaving us stockholders holding the bag. I’m out and staying out. American Realty Capital Properties (ARCP): Minor accounting issues blew the top off a company with excessive compensation, conflicts of interest, excessive risk-taking and more. Management and the company name have been changed to Vereit (NYSE: VER ), but the point is that big losses were avoided by investors who heeded problems which were well known before the blowup. The entire medical marijuana industry: Marijuana has attracted more serial fraudsters, incestuous management and shareholder abuse than any industry in living memory. For an unfortunately common example, see this article on Medical Marijuana ( OTCPK:MJNA ), trading at three cents a share and a long history of issuing new shares to insiders like Halloween candy. To see how pervasive shareholder abuse is in the industry, see this article and others by Anthony Cataldo. Standard Metrics of Effectiveness Standard metrics that directly affect the bottom line are still the most important area of management assessment. They show how skilled executives are as businesspeople and are clearly related to the shareholders relationship. Revenues and profits matter. Metrics like return on assets (ROA) and return on equity (ROE) show how efficiently management utilizes the resources available to them. Debt/equity and debt/earnings can show the degree of risk that management is exposing shareholders to. Conclusion Complacency is deadly. For six years investors have been lulled into a sense that picking investment winners is easy, or at least something they have largely mastered. Conditions are changing however, in ways that will make successful management more challenging and will separate the good from the bad. Recognition of excellent management will be more critical to investment success and in some cases company survival. Standard measures of management effectiveness like return on assets and return on equity are still the first place to go, but they don’t tell the complete story. Excellent management is also identified by the relationships with three key constituencies: customers, employees, and shareholders. Excellence is defined by integrity, respect, and fairness with these three groups. A few examples of how to identify the best and worst companies are given here – there are many others. Choosing investments based on a comprehensive determination of excellence will enable us to be successful in even the challenging times. In addition, we can have the satisfaction of knowing we are associating with individuals that are not only talented, but act honorably and ethically towards others. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Scalper1 News
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