Watch Out For Used Car Salesmen Masquerading As CEOs

| January 14, 2010 | 0 Comments

“It sounds to me a little bit like selling a car with faulty brakes, and then buying an insurance policy on the buyer of those cars.”  That’s how Phil Angelides, Chairman of the Financial Crisis Inquiry Commission, characterized the behavior of Wall Street’s biggest banks.

In case you missed it, the Commission held its first hearings yesterday into how the banks’ conduct led to last year’s near meltdown of the financial system.  Mr. Angelides didn’t pull any punches when he compared these “Masters of the Universe” to used car salesmen.

That comment and another one by Mr. Angelides got me thinking.  Both of them address something every investor needs to take to heart.

He said, “I am troubled by the inability [of bank CEOs] to take responsibility because I think it’s fundamental.”

I bet you’re nodding your head in agreement.  It’s such a simple truism.  When you make a mistake that hurts someone else, you ought to acknowledge what you did was wrong and take responsibility for your actions.

That’s one sign of good management…

One of my favorite quotes by Warren Buffett sums it up perfectly…

In evaluating people, you look for three qualities:  integrity, intelligence, and energy.  And, if you don’t have the first, the other two will kill you.

But, how can we as small-fry investors tell if management’s honest?

We don’t know these people.  We don’t have an opportunity to look them in the eye and talk to them directly.  How can we really size up someone’s character if we can’t interact with them in person?

We all know the insatiable greed of Wall Street fat cats was the source of the financial crisis.  But, they’re not apologizing and taking responsibility.  They’re busy profiting from the aftermath… and blaming the government for letting the banks take on too much risk.  (Now that’s just downright disgraceful in my book.)

This is not the kind of behavior I want to see from the executives of companies that I invest in.  And, you shouldn’t either.

What we’re really talking about here is honesty and integrity.

These are the most important, most fundamental character traits I look for when assessing a company’s management team.  If the CEO and top executives lack these qualities, you can be sure the company’s headed for trouble.

It all starts with diligent research.

Read the company’s annual reports from oldest to newest.  These will give you a good idea about management’s perspectives, strategies, and goals.  By reading them in chronological order, you can get a feel for how consistent and reliable management is.

It’s also important to go back and review press releases, quarterly earnings reports, interviews, speeches, and the company’s website.

These too provide insight into the character of a company’s management team.  Lucky for us, the internet makes it very easy to gather this information quickly and conveniently.

Most investors don’t take the time to properly assess the quality of a company’s leadership before buying the stock.

They usually spend all their time reviewing the company’s fundamental data or studying the stock chart.  Those are very important parts of the research process.  But you need to spend some time assessing the quality of the people running the business.

Sometimes you’ll spot trends in management behavior that gives you pause.

For example, you might find that a hotshot CEO has a history of sweeping problems and bad news under the rug.  And when the problems finally come to light (they always do), the arrogant CEO will shift the blame elsewhere rather than take responsibility for them.

Avoid companies whose managers are not “candid” with shareholders.

Good managers freely admit their mistakes.  By admitting their mistakes, they can study and learn from them.  And, they’re more likely to correct problems before they blow up and cause catastrophic failures.

Of course, honesty and integrity aren’t the only qualities a good management team should have.

They should also be highly rational and intelligent.  Do they make good decisions about allocating capital?  Are they focusing on what really makes sense for the business and shareholders?

And, good managers are able to act independently of external and internal pressures.  They’re able to resist what Buffett calls the “institutional imperative”.

The institutional imperative is a combination of influences often pushing managers to act in unreasonable ways.

For example, Wall Street analysts, fund managers, and large shareholders are extremely focused on the short-term.  They reward and punish companies based on quarterly results.

This pressure to produce results today (no matter what) has caused many a CEO to cut corners.  Many will pursue strategies that aren’t in the company’s best interests.  While it’s important to deliver consistently good results, it’s more important to do what’s necessary to promote the company’s growth over the long run.

A good CEO understands how these forces work.  And, he’s able to balance the needs of institutional investors for short-term results with the need to successfully grow the company longer-term.

Next time you’re researching investment opportunities, make sure to spend some time assessing the quality of management.  You might see things that help you avoid the next Bear Stearns or Enron.  Remember, the numbers and chart patterns are important, but the values of the people calling the shots are critical for long-term success.

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Category: Stocks

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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