Assessing management is a big part of the investment process. But don't take whatever is said at face value. Nitin Jain of Candid Capital shared with me details on how to approach company management when you are invested in the stock.
Investors approach company management with these preconceived notions.
- Managements will always speak truthfully
- They can be held accountable for what they say
- They have to disclose everything to help investors make an informed decision
Does reality play out as expected? Not at all. Reality is about selective disclosures and over commitments to appease investors’ expectations. That is why investors need to be on top of the game when it comes to interacting with the management and asking the right questions.
In an interview years ago, investor Tom Russo said that William Ruane used to ask managements, “What are the chances that your business will lose money next year?” The management team would be either perplexed or disturbed, but they would eventually say something like, “Well, for that to happen, the following three things would have to happen.” That, Ruane believed, were the three things you should care about.
Don’t take statements at face value.
- In next 10 years, contribution from our new business initiatives will exceed our traditional businesses.
Check how the business composition has changed over the last decade and try to figure out whether the company has demonstrated any intention to make a change. The coming decade is a long way to go and you will have sufficient time to catch up. Don’t be in a hurry to give new valuations to the current business. Don’t fall for the FOMO (Fear of missing out) game.
- Our team did a brilliant job in such a difficult environment.
Undoubtedly, and they should be commended. But you should not stop at plain narration of the reported results. Look for a constructive analysis; the lapses and the hurdles overcome during this period.
- A new CEO has come on board who is a veteran.
If it is the situation of the individual getting a bigger role within the group, then it is not a cause for alarm. However, if he has joined a competitor, then all the more important as to what led to the exit. Senior employees normally stick on with employers they believe they have a future with.
When a company makes a high profiled recruitment, there is a lot of brouhaha around it. Earlier this year, when Sudhir Sitapati was appointed as the MD and CEO of Godrej Consumer Products (GCPL), the share price soared. But notice the muted reaction when an exit takes place. When Zomato co-founder Gaurav Gupta resigned, it was confirmed on Twitter.
Develop the knack of asking pertinent questions.
Phil Fisher’s most important question to management: “What are you doing that your competitors aren’t doing yet?” While that is a generic one, let me share an example as to how you can sharpen your investing acumen.
In 2019, the CEO of D-Mart made a statement to the effect that he was dissatisfied with the progress made on store openings. "This year has not been satisfactory on store openings. We opened only 21 stores. We aspired to open much more but that didn’t happen. Same store sales growth (SSSG) partly made up for this drop in store openings. Our SSSG has pleasantly surprised us and also encouraged us to get further better at execution.”
Many would have considered that a negative. I found it extremely comforting. D-Mart opened its first store in 2002 and then restrained its expansion for a few years. The reason for this company’s success is that its focus has always been on learnings, not headline management.
So should I hear about a plan to “open 100 stores in the next 12 months”, I will not fall for the rhetoric. I will question. What is the source of funding? How much of debt will be incurred? What’s the composition and the experience of the team responsible for this execution? How many stores have been closed over the past years? What have been the learnings from them and how are they being incorporated into future expansions? How viable are the locations? Have the locations been identified? I would be happy if the company refused to open even a single store the entire year if a viable location could not be identified.
- We started/acquired this business 5 years ago. We are committed to turn it around over the next 2 years.
What have they achieved over the past three years? Did they have a shorter time frame that was extended? If yes, why have they not achieved their goal? Have they resolved the issues that hindered them? If they have still not achieved it, why are they so sure of making it happen within the next 24 months?
- The new car model that we are launching is disruptive and is destined to be a category leader.
Can you share the lessons learnt from the previous highly touted models that failed to perform? How are you incorporating those lessons to make the new launch a sustained success?
- We got 50,000 bookings for our new model in under three hours.
How many of these bookings do you anticipate getting cancelled before delivery? What are the scheduled delivery timelines given the chip shortage and your production capabilities? How sustainable is this demand? What are the margins on this model? Given that this model has heavy electronics, how will the company ensure good customer service and experience?
Remember this 8 guidelines:
- Predictions and Visions are great. Dig deeper to see what happened to past promises and assurances.
- Never ignore a company’s track record on delivering on its promises. It is the past vision that has resulted in the present reality.
- Hear what they tell you. But try and find out what it is that they don’t want you to know.
- Don’t hesitate to cut through the fluff and ask yourself what really matters.
- Replace the bubbling optimism with a good dose of realism. Remember, it is your money at stake.
- Managements in general will emphasise the positives while trying to negate the negatives by either not highlighting them at all or attributing them to the external factors. Be aware.
- They will also portray an extraordinary future by playing the FOMO (Fear of missing out) game. Don’t fall for it.
- Ask open-ended questions. For instance, if it is a new CEO, don’t just stop at “what is his prior experience?” Take it forward with, “How did you arrive at the decision to hire him/her, and how did they stack up against other candidates?”
Nitin Jain blogs at invest4
Larissa Fernand is Senior Editor at Morningstar India. You can follow her on Twitter.
