Saturday, September 18, 2010

The Human Aspect of Investing

We often talk and think about investing in terms of numbers, business models and facts; but when you really drill down to it, investing is actually all about people. Why do I say that? This is because corporate fundamentals are built upon the people who run the business, people who delegate the work to others; and the rank and file staff who execute the mundane (yet necessary) daily transactions. Without the role of people and human beings, investing would not even exist! However, this post is not to extol the virtues of humans within organizations; in fact it seeks to take a closer look at the very aspect of investing which is almost impossible to quantify – that of the quality of the Management Team, Directors and staff on board. In short, this post is to discuss the human aspect of investing in creating a successful corporate culture, identity and how it adds up to creating enhanced shareholder value.

Interestingly, I once read an investment book which did mention about the importance of assessing Management characteristics (sorry, I can’t remember the title!). But the crux of the book was that investing is more than just the sum of the parts in terms of assessing aspects of the company such as market share, financials, industry analysis and business models, which are the so-called “tangible” aspects of the business and which can be readily scrutinized. Management and people, on the other hand, are a part of the business which adds an extra dimension of quality without being directly measurable or tangible. The converse is also true if a good business is being run by crooks – sooner or later the Company will implode under mis-management and fraud. I think what the book wanted to stress was the kind of people out there which a retail investor might meet and how to size them up in order to enhance our view of a company as a potential investment.

I think for this post, I would confine my discussions on human behavior and personalities to CEOs or Chairmen, as they are the people in charge of steering the Company ahead and are usually the ones who are “on top of things”. Most of the company’s strategic vision is also embodied and articulated by top management; hence the cues given out by these people will mean much more than signals given out by, say, the finance manager or the marketing director (for example); even though of course one should also try to speak with them on the Company to get a broader perspective of things. However, I have noticed that corporate behavior tends to cascade down from the top, and “infect” the entire organization, be it good or bad. If a CEO has the habit of hiding bad news from his staff, then his staff will similarly try to hide bad news from investors and the media. If a CEO is open, honest and forthcoming, it is also likely to flow down to his management team and it will show up clearly as well.

So what are some of the good traits to look out for, and which can give an investor confidence in the Company? For one, a CEO has to be open, honest, inclusive and not afraid to admit mistakes. This can be very easily deduced from the Chairman/CEO’s statement in the Annual Report, and also from conversing with the person during the AGM. A CEO who is open will share the good and also the bad bits from the last financial year, and be candid about the state of affairs of the company. After all, it cannot possibly be good news all the way, and even if things look good for the company, it is the prudent CEO who will temper expectations and not be overly optimistic. The CEO should also be willing to share his mistakes, admit them openly and assure shareholders and investors that he will not repeat such mistakes; and it takes a very brave CEO to admit he made errors, as it is a natural human inclination to accentuate the positive and bury the negative.

Other positive traits to watch for are a passion and drive to grow the business beyond the current state of affairs, and having the right strategy, knowledge and foresight to grow the business; yet manage the cash flows and Balance Sheet of the Company well at the same time. This, of course, can be deduced from the financials over the years, but when one comes into contact with a CEO, watch how he talks about his company and his plans for the company. Some CEOs are simply unrealistic and will project 50% CAGR in revenue and earnings for the next 5 years, others have their head in the clouds all the time dreaming of the big break for the company (with a new technology or patent); while the more pragmatic ones will have a more realistic target like doubling sales in 5 years for example (which is achievable because it’s not doubling of profits). The important thing here is to weigh your view of the Company’s prospects against what the CEO is projecting or forecasting, to see if the person is a realist or an unjustified optimist. The CEO who blows his trumpet in public may very well delude himself in private that he is somewhat special and can take the company through all obstacles, and so end up acting in an impetuous and brash manner which may result in the company’s fortunes sinking over time.

I guess I had already alluded to some negative traits in the above paragraph, and these include arrogance, refusal to admit mistakes, a flippant attitude, aggressive behavior (not physical but in the allocation of capital) and poor knowledge of the industry or his company’s place within the industry. Some CEOs are pretty new to the job, hence may be green around the ears and new to the job. Others may be very “PR”, and laugh and chat with shareholders and fund managers, but if you look closer there’s actually not much substance. I could certainly go on to give examples, but I think the reader should get my drift at this point.

To be able to ascertain a CEO’s competence and character from a meeting at the AGM is certainly not a simple task, even if one can pick up subtle cues here and there. Usually, one should do his homework and read up about the person prior to the meeting, and also understand more about the company and peruse through the Chairman’s Statement and MD&A. If this is done studiously, a lively engagement will then ensue and you can literally “test” the CEO to see if he can handle your questions, and also note his body language when he responds.

To conclude, I will say that often times, investors neglect this very important aspect of investing which is the human touch. Though it may not be easy to assess, I feel it should still remain an integral cornerstone of investing and should be worked on. My method was to attend many AGMs and EGMs or any briefings or press conferences which featured the CEO or Chairman in question, and proceed to observe and learn. Over time, one can accumulate sufficient experience to judge character and be able to distinguish the good, the bad and the downright ugly!


Ben said...


I believe that time will tell whether CEO is capable of producing results for the company.

Attending AGM is one way of knowing more about the CEO's plans as well as his character.



Musicwhiz said...

Hi Ben,

Yes, very true indeed! Time will tell if a CEO can deliveror if he is just hot air. But sometimes reputation may precede him, and investors may have higher/lower expectations as a result.

Some people argue that you cannot get much out of meeting a CEO for like 30 minutes; but I feel it's still better than not meeting the person at all!


Chin Yee Hong said...

Hi Musicwhiz,

I think that the efforts of a capable CEO will show up in the financial statements. If the CEO is really good, the ROE, profit margin, cash flow will improve.

However, if you really found a really good CEO, is it a good idea to pay a premium for the stock?


Musicwhiz said...

Hi Yee Hong,

Yes, I agree! Actions will translate into results, but one must allow for time to show the effects of growth and good management.

If there is a competent CEO at the helm, I still may not pay a premium. There are other factors to consider such as the business model and industry as well. I'd say it will be on a case by case basis.