At the final stage of fundamental analysis, the investor analyses the company.
This analysis has two thrusts:
1. How has the company performed vis-à-vis other similar companies? and
2. How has the company performed in comparison to earlier years
It is imperative that one completes the economic analysis and the industry analysis before a company is analysed because the company’s performance at a period of time is to an extent a reflection of the economy, the political situation and the industry. What does one look at when analysing a company? There is no point or issue too small to be ignored. Everything matters.
The different issues regarding a company that should be examined are:
1. The Management
2. The Company
3. The Annual Report
4. Cash flow
5. Ratios
The Management
The single most important factor one should consider when investing in a company and one often overlooked, is its management. It is upon the quality, competence and vision of the management that the future of company rests. A good, competent management can make a company grow while a weak, inefficient management can destroy a thriving company. Indian corporate history has many examples where an able and visionary management has worked wonders for companies and their stock prices. Sunil Mittal of Bharti Airtel, Azim Premji of Wipro, Narayan Murthy of XYZ, Deepak Parekh of HDFC, are few such examples where the management of the companies headed by strong leadership have helped companies create significant wealth for their investors.
In India, management can be broadly divided in two types:
1. Family Management
2. Professional Management
Family management
Family managed companies are those that have at the helm a member of the owner or controlling family. The Chairman or the Chief Executive Officer is usually a member of the controlling family and the Board of Directors are peopled either by members of the family or their friends and associates. All policy is determined by the controlling family and while some policies may be good, some of the policies may not necessarily be in the shareholders’ best interest. The advantage of such companies is the loyalty family members would have to the company which they consider their own. Earlier, family managed companies were often orthodox, autocratic, rigid and averse to change. This is no longer true. There have been some changes in the way family controlled businesses are managed. In many family managed companies, although the man at the helm is a scion of the family, the management is run by professional managers. Many such businesses are very successful.
Professional Management
Professionally managed companies are those that are managed by professionals who are employees of the company. In such companies, the chief executive officer often does not even have a financial stake in the company (or a minority stake). He is at the helm of affairs because of his ability and experience. The professional manager is a career employee and he remains at the seat of power so long as he meets the company’s business targets. Consequently, he is always result-oriented and his aim is often meeting the annual budget and business targets. He may not necessarily be tied to the company by loyalty but is focussed on performance on a consistent basis which improves shareholder value. As a professional he is usually aware of the latest trends in management philosophy and tries to introduce these to maximise employee performance. He tries to run his company as a lean, effective machine striving for increased efficiency and productivity. As a consequence professionally managed companies are usually well-organized, growth-oriented and good performers. Companies that come readily to mind are ITC, HDFC, Hindustan Lever, L&T to name a few. One disadvantage of professionally managed companies is that the professional managers may leave the company for better pay and perquisites offered by another company. This is a loss for the company especially if the person is a high performer. Many companies therefore promote or create long term commitment and loyalty by offering employees stock options (i.e. giving them shares of the company). The employee thus becomes a part owner and becomes interested in the sustainability and profitability of the enterprise. It is a win-win situation for both. The company gets the services of a loyal competent employee. The employee builds his wealth. It is a fact that in many professionally managed companies there is corporate politics. This is because managers are constantly trying to climb up the corporate ladder. The end is often what matters, not the means. Often too, as a consequence, the best person does not get the top job; rather losing out in the political environment. This does not always happen in family managed companies as one is aware that the mantle of leadership will always be worn by the son or daughter of the owner.
What to look for
It would be unfair to state that one should invest only in professionally managed companies and overlook family managed companies. There are well managed, profitable companies in both categories. There are also badly managed companies in both categories. What then are the factors one should look for?
• Integrity of Management
The most important aspect is management integrity. This must be beyond question. It is often stated that a determined employee can perpetrate a fraud, despite good systems and controls. Similarly, if it so desires, the management can juggle figures and cause great harm and financial loss to a company (for their own personal gain). Tracking integrity may not be easy but over time managements distinguish themselves from others on issues of honesty and integrity.
• Past record of management
Another point to consider is proven competence, i.e. the past record of the management. How has the management managed the affairs of the company during the last few years? Has the company grown? Has it become more profitable? Has it grown more impressively than others in the same industry? It is always wise to be a little wary of new management and new companies. Wait until the company shows signs of success and the management proves its competence.
• How highly is the management rated by its peers in the same industry?
This is a very telling factor. Competitors are aware of nearly all the strengths and weaknesses of management of their rivals and if they hold the management in high esteem it is truly worthy of respect. It should be remembered that the regard the industry has of the management of a company is usually impartial, fair and correct.
• How the management fares in adversity?
In good times everyone does well. The inherent strength of a management is tested at times of adversity. During a time of recession or depression, it is important to consider how well the management did: Did it streamline its operations? Did it close down its factories? Did it (if it could) get rid of employees? Was it able to sell its products? Did the company perform better than its competitors? How did sales fare? A management that can steer its company in difficult days will normally always do well.
• The depth of knowledge of the management
Its knowledge of its products, its markets and the industry is of paramount importance because upon this can depend the success of a company. Often the management of a company that has enjoyed a preeminent position sits back thinking that it will always be the dominant company. In doing so, it loses its touch with its customers, its markets and its competitors. The reality sinks in only when it is too late. The management must be in touch with the industry and customers at all times and be aware of the latest techniques and innovations. Only then can it progress and keep ahead. A quick way of checking this is to determine what the market share of the company’s products is and whether the share is growing or at least being maintained.
• The management must be open, innovative and must also have a strategy
It must be prepared to change when required. It must essentially know where it is going and have a plan of how to get there. It must be receptive to ideas and be dynamic. A company that has many layers of management and is top heavy tends to be very bureaucratic and ponderous. There are “many chiefs and few braves”. They do not want change and often stand in the way of change. Their strategy is usually a personal one, on how to hold onto their jobs.
• Non-professionalised Management
It is not recommended investing in a company that is yet to professionalize because in such companies decisions are made on the whims of the chief executive and not with the good of the company in mind. In such companies the most competent are not given the positions of power. There may be nepotism with the nephews, nieces, cousins and relatives of the chief executive holding positions not due to proven competence but because of blood ties.