Investment Shastra

How to choose good stocks: Look for a trustworthy management

An excellent financial track record and a sustainable competitive advantage are two important characteristics to help shortlist a wonderful company. But one more characteristic is required to guarantee a future winner, and that is a trustworthy Management.

Consider this: A company, XYZ Ltd., has performed robustly in all its financials over the last few years, growing its sales & EPS at an impressive rate. Also, it has a sustainable competitive advantage. And it is currently undervalued, too! So, how tempted are you to invest in it? Very much!

But, there’s a small catch. Its Management is infamous for giving false information, arrogance with minority shareholders, insider trading or paying too much to themselves. Now, think again. Even though, this company may be a winner in future, you probably cannot trust its Management to take care of your money.

You need to stay invested with a Management which is trustworthy and respects your interests. Here are a few indicators that can help you assess the trustworthiness of a company’s Management:

  1. Aligned with your interests: Check whether the Managements’ interests are aligned with the shareholders’ interests. Check for the following clues:
  • Vision and plan: Does the Management share a vision that appeals to you and have a plan to implement it?
  • Compensation of Top Management: Is the compensation they pay to themselves reasonable enough? If the Management is paying obscene amounts of money to themselves, even when the company’s profits suffer, it is better to stay away.
  • Decreased interest in the company: Is the Promoters’ interest in the company decreasing? For this, check whether –
    1. The Promoters are reducing their stake-holding often.
    2. The CEO and Top Management are selling/exercising their stock options periodically.
    3. The Promoters are pledging their shares.
      If the answer to any of the above (1, 2 or 3) is yes, then obviously the Promoters have a short-term interest in their company. Hence, it is better to stay away from it.
  • Buy-Back of shares: If the company buys back its shares at a time when the market is undervaluing its stock price, it usually is a reflection on its Management’s confidence in the growth of the company.
  1. Qualified: Is the CEO is qualified to run the company? Does s/he understand the business well enough to run it well?
  2. Transparent: Is the Management upfront about the actual threats and concerns the company is facing? Does the Management sometimes accept that it made a mistake? Management can make mistakes, and a trustworthy Management admits them.
  3. Pays dividend in case it is unable to increase the company’s ROE further: Logically, the company’s net profit should be distributed among shareholders as dividend. But, generally, the company retains a part or the entire profit and re-invests it. What does a good Management prefer: paying dividend or retaining the profit?A good Management retains a part/entire profit, only when it is able to earn a handsome return on it; otherwise it pays dividend.

To get answers to the above questions, look at a company’s Annual Report, especially the Directors’ Report, Chairman’s speech & Management Discussion and Analysis.

A good benchmark for Trustworthy Management is Bajaj Auto. Rajiv Bajaj (Managing Director of Bajaj Auto) has an acute business sense. The Management of Bajaj Auto has been prudent in its operations, and you will find them being very candid about the threats and concerns in Management interviews/news items/Annual Report. They also disclose the Management remuneration in their Annual Report.

In a nutshell, you are looking for a leader who lives and breathes his/her company, someone you can trust your hard-earned income with!

Read the next blog to know, What is the Right Price of a stock? How do you asses the Intrinsic Value of a stock?


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