When James Montier penned his paper Seven Sins of Fund Management, he wrote that he found the insistence of spending hours meeting company managements as bizarre, strictly from a psychological standpoint. He subscribed the behaviour pattern that humans are not good at looking for information that will prove us wrong. And since our ability to spot deception is also poor, we won’t come away wiser.
Not many agree with him.
Todd Wenning of ClearEyesInvesting.com agrees that the issue of whether or not one should meet with a company’s management is a debatable topic among fundamental investors. Those against it believe you can get what you need from the numbers and company filings.
Having acknowledged that, Todd, also a generalist analyst on Johnson Investment Counsel's SMID-cap strategy, says that in his experience, speaking with business leaders across industries, company sizes, and geographies has been an education in itself. While he has misread situations, he has learned more than he has lost and has come to enjoy the art of crafting questions. Despite the risks, meeting with management also helps one evaluate the intangible factors that may not be priced into the stock.
Todd lists 15 questions to ask management teams that would help investors not succumb to the risk of getting "captured" by a charismatic executive or misled by a sly one.
1. What is distinctive about your company's corporate culture?
This is the first question I ask. Not only am I genuinely interested in learning about the company's culture, but it also sets the tone for the rest of the conversation. Most CEOs and CFOs get peppered with questions from analysts and investors about the quarter or annual guidance. Naturally, then, most start the call on the defensive.
Starting with a qualitative question that gives them the chance to discuss why their company is a great place to work has in more than one occasion dramatically shifted the conversation's temperature.
2. If you had to live on a desert island for 30 years and could only invest your life savings in the stock of one of your competitors while you were gone, which one would it be?
This question has generated some good leads. When a company speaks well of a competitor, that's usually a sign the competitor is doing something right. Some executives prefer to punt on this question - and, of course, it's worth asking yourself why they'd punt. When this occurs, I'll replace "competitors" with "customers or suppliers," with the idea being to find out which companies might be worth further research.
3. What has the company done to widen its moat over the past year?
The phrasing of this question requires the executive to know the company's core durable competitive advantages (its "moat") - which is not always a given - and then know how the company has deliberately improved upon that advantage. For example, if the company's moat is brand-based, you want to learn how management has made the brand more valuable. If it's a low-cost producer, how has the company improved cost controls?
4. Could you please walk me through your M&A process?
What I'm looking for here are signs of a repeatable and thoughtful process. Is there a dedicated acquisition team? How are they valuing targets? When do they walk away from deals? Have they walked away from deals?
5. What's been the biggest change in your industry over the last five years?
Companies don't operate in a vacuum and it's important to know how industry dynamics have impacted the business. Has there been consolidation? Did a big company go bankrupt? Did manufacturing move overseas?
6. What are you doing that your competitors aren't doing yet?
This is one of Philip Fisher's questions. It's perfect as it is and I love Fisher's emphasis on the "yet." It's a good starting question for economic moat evaluation and it can also help you determine if management is taking new competitive threats seriously or not.
7. In what ways is technology an opportunity and in what ways is it a threat?
Software is increasingly able to replace labor- or capital-intensive operations. You want to find out which parts are most threatened by this development, but also which parts might benefit from technology (i.e. lower costs, streamlined operations, etc.).
8. If I had sufficient capital, what would stop me from competing head-to-head with you in year one?
Here, what I want to find out is if there are any barriers to entry beyond capital. If returns are good enough, capital will find its way into the industry. So, in order for an economic moat to be present, the company has to do something (customer relationships, manufacturing know-how, access to a scarce asset, etc.) that money alone can't buy.
9. What do investors underappreciate about your business?
This can be an effective question for mid- and small-cap firms (due to less sell-side coverage) and those that have secondary or tertiary business lines. Here's an example. I was speaking with bank CEO whose company had a fair amount of sell-side coverage. When I asked him this question, he said (paraphrasing), "You know, the analysts that cover us are bank analysts and they don't ever ask about our (multi-billion dollar AUM) asset management business."
He then went into detail about how well the asset management business is doing. That was a signal to start digging into the asset management business to verify the CEO's claims and determine whether or not the market was taking that operation into account.
10. What's your philosophy on buybacks and dividends?
Again, what I'm looking for is thoughtfulness when it comes to capital allocation.
Have they considered the positives and negatives of both and determined the optimal mix? Why is it the optimal mix for their shareholders? Do they properly use buybacks or do they have an ulterior motive (i.e. boost EPS, offset dilution, etc.).
On dividends, I want to find out if the dividend policy (if there is one) is appropriate for the firm. A highly cyclical company, for instance, will ideally have a small "normal" dividend followed by a special dividend in good times. Firms with more predictable cash flows, on the other hand, can reasonably target a higher percentage of free cash flow or earnings to return each year.
11. Who covers you well on the street?
There are two benefits to this question. First, if there's a sell-side analyst who has covered an industry or company for a long time, they can be valuable resources for learning the company's backstory, which managers are talented, and which competitors pose real threats.
Second, I want to find out if management only recommends analysts who currently have "buy" ratings on their stock (which tells you something) or if they care more about which analysts follow them thoroughly and honestly, even if they might disagree with the analyst's current rating.
12. If your company didn't exist tomorrow morning, what would your customers miss about it?
This question also touches on the company's economic moat sources. If the company disappeared and its customers could easily switch to a competing product and wouldn't miss doing business with it, then it's difficult to justify the existence of an economic moat today.
13. What do your customers complain about the most and how are you addressing that issue?
One reason I like this question is that it helps me determine whether or not management likes to own up to its mistakes and the company's flaws. If they sidestep the question, that's a problem. Every company has shortcomings. It also helps me gauge how pressing the problem is and if the company is fully engaged in the process.
14. Do you have any good book recommendations?
I can't tell you how many times I've heard, "I just don't have the time to read." This could suggest the executive is overworked or unorganized - and neither is an appealing trait.
A CEO who likes to read, in itself, is not reason enough to invest, but it is an indication to me that he or she is intellectually curious and looking to improve themselves and the business.
15. Why is that?
At least once in every conversation, I aim to follow up a question with, "Why is that?"
It's such a simple question, but it gets closer to the heart of the matter. By understanding the governing principles of a business or management team, you can better anticipate what the next moves might be.
