​In our experience management quality is arguably the number one determinant of a company’s long term success. We believe this is more leveraged in a smaller company because each strategic decision can have a larger impact on the future of the business from a relatively lower base. This means getting to know management is an essential part of our investment process. In this article we discuss what we look for in a high quality management team.

We believe management quality is the most important single factor to get right when investing in a smaller company for the long term. There are a number of key reasons for this:

• Management make the strategic decisions which will determine a company’s long term growth prospects or lack thereof;
• Management set the tone for a company’s culture – all employees are guided by management thinking and behaviour;
• Employee turnover will be directly impacted by the quality of management – as the saying goes; people don’t leave companies, they leave bosses.
• Management are the face of the company in financial markets and investors will ascribe a higher value to high quality management teams and vice versa;
• Ethical management teams provide effective risk mitigation against a multitude of risks including fraudulent behaviour, misrepresentation, insider trading, etc.

The list could go on. Suffice to say, picking the right management teams to invest in is an important part of our investment process. Now onto the factors we look for in high quality management teams…

In our experience, it is best if management can explain their strategy to investors simply and clearly, and without the use of too many words. This elevator pitch concept is a great way of filtering out complex business models as our best performing stocks have almost always been simple and easy to understand businesses. We believe the simpler the business model to understand, the less moving parts in general, and thus the less unforeseen risks lurking in the background.

Stock example: Joyce Corp (ASX:JYC) management are great example of a clear communicating management team. Whenever we meet management or read through the company’s investor presentations we are 100% clear on where the business is going longer term.

We like to invest with management teams who have worked their way through the ranks of an organisation over an extended period of time. These types of managers tend to understand the business better than newcomers who go straight into a top level executive role. And importantly, long term managers will have seen the business through different economic cycles, and thus tend to understand what needs to be done to manage sustainable long term growth.

Stock example: Pioneer Credit’s (ASX:PNC) CEO and founder, Keith John, has been working in the business since the company’s beginnings and in our opinion knows everything there is to know about his business.

We are looking for management teams who will put their shareholders first which tends to reflect itself in:

• Paying dividends when it is in shareholders’ best interests.
• Returning capital when it is in shareholders’ best interests.
• Regularly consulting with shareholders for honest feedback.
• Factoring shareholder feedback and interests into strategic thinking.

This one seems obvious but it is relatively unusual in our experience. We like to come out of management meetings inspired by management’s energy in the room, and with the feeling that management are having fun in their job. This can only really be gauged through face to face management meetings.

Stock example: (We will need to keep this stock’s name confidential so as not to cause offence.) We recently had a meeting with a management team who were clearly down in the dumps about their business prospects. And importantly, their energy had turned negative after a difficult year whilst their thinking had become defensive. We left the meeting exhausted by the negative energy from the meeting. This is clearly the opposite of what we look for.

We have found ourselves increasingly aware of how humble (or not) management teams are in recent years. In hindsight, this can be explained by our belief that that the least humble, most arrogant management teams have tended to disappoint us over the long term, whilst the most humble management teams have tended to perform the best. There is a great Conversation article on this subject (see website link in references) which confirms our sneaking suspicion that humility in management tends to correlate with long term stock out-performance, and goes on to explain that it is remarkably hard to find humble CEOs these days for the very reason that they have reached the top of the corporate ladder by being highly confident:

In recent years having skin in the game has become a widespread market expectation as the empirical evidence shows that companies run by management with significant stakes in the business significantly out-performs over the long term:

We concur, and aim to invest alongside management teams who are significant shareholders in their business.