books about online stock trading, forex, futures, stock investing, market, trading systems
Research Stock Character
Back to contents page

Compensation by itself is often a good litmus test for character—anecdotally, there's a pretty strong relationship between management teams that are in it for the money and management teams that treat shareholders poorly. However, there are some other important questions you should ask to get a handle on whether a firm's management deserves your trust.

Does Management Use Its Position to Enrich Friends and Relatives?

In a company's annual 10-K filing, look for a section called "related-party transactions." If a friend or relative of a company officer has substantial busi­ness dealings with the firm, you'll read about it here. Often, this stuff is pretty innocuous—an ex-officer or director is paid some nominal amount each year for consulting services. As long as the firm isn't paying out hundreds of thousands of dollars, this kind of thing doesn't get my hackles up.

But when the firm pays substantial amounts of money to, for example, an interior-design firm run by the CEO's wife or to a law firm in which the CFO's son-in-law is a partner, I sit up and take notice. The key here is to make sure that (1) the firm isn't sending a great amount of business in the direction of related parties and (2) there's not an egregious pattern of abuse. One or two small related-party transactions aren't a big deal, but they do cause me to raise an eyebrow because they may be signs of a deeper problem. And if it looks as though virtually all family members of the company officers have their hands in the till, you have a big character issue.

Is the Board of Directors Stacked with Management's Family Members or Former Managers?

Look at the biographies of the board, which are also in the proxy statement.

If many of them are closely related to top management—or are former managers themselves, it's a good bet the board isn't going to be as hard-nosed when questioning management's actions as it could be. And because the board is shareholders' last line of defense against a CEO running amok, that's hardly a good thing.

Is Management Candid about Its Mistakes?

Not even the smartest executives get everything right, and it's important that a management team be able to honestly discuss poor decisions and why they were made. CEOs who bury mistakes might be burying other things as well. Look for this type of candor in annual reports and in quarterly conference calls. I especially like to look at the letter to shareholders in the annual report. Is it a candid assessment of the past year's successes and failures or a fluff piece?

How Promotional Is Management?

Although a certain amount of rallying the troops is the job of a CEO, watch out for company officers who cross the line and begin blindly pumping up the stock or themselves. This is a red flag because management's job is to worry about running the company—if executives get that right, the stock price will take care of itself over time. Executives who complain about how undervalued their firm's shares are or who opine about its true worth are probably more concerned with the value of their options than with making solid, long-term business decisions. Self-promotional managers, meanwhile, are not likely to make decisions that are in the best interests of long-term shareholders. If you read a number of glowing media articles in which a CEO paints himself or herself as a latter-day savior, watch out. The cult of the CEO-as-hero is dangerous.

Can the CEO Retain High-Quality Talent?

This one is subtler, but it can tell you a great deal about the firm you're analyzing. Some firms judge the quality of managers by the turnover rate of their subordinates because turnover is seen as the ultimate acid test of the working environment and employees' views of a company's potential. Extend this view to the executive team: How often do officers turn over? What is the tenure of key officers? Is executive hiring done from the outside? (All of this can be uncovered by reviewing several years' worth of proxy statements.) Long tenure is a great signal of intrinsic motivation and confidence in the business, whereas a CEO who keeps forcing out immediate subordinates is likely spending too much time on internal power struggles and not enough on running the business.

Does Management Make Tough Decisions that Hurt Results but Give a More Honest Picture of the Company?

If a management team makes decisions that actually hurt reported results, you're in luck. Management teams that use restricted stock grants instead of options—because the former has to be expensed, while the latter doesn't—or who expense rather than capitalize items such as research and development or software costs are the kinds of folks who are more interested in running the business than playing numbers games. And those are precisely the kind of people you want running the companies you own.

Smarter trading The art of day trading Trading Chaos Sane Investing In An Insane World
Beat The Odds In Forex Trading