EVALUATING MANAGEMENT We hear this all the time in the stock market. A company has "great CEO" or an "awful management team". These are vague terms that, more often than not, are highly correlated with the recent performance of a stock. John Foley of PTON was hailed as a
"visionary" when the stock was at $150 and a "chump" when the stock went to $10. Which one was true? In my experience, evaluating management is simultaneously one of the most critical elements of stock selection success and one of the most difficult. CEO's get to the coveted
corner office by being incredibly smooth, persuasive communicators, who are highly incentivized to maximize their stock price. Lee Ainslie from Maverick noted in the December '06 issue of Value Investor Insight "our entire investment team has also had training in interview
techniques & lie detection. I don't think you can spend too much effort trying to understand the quality of management - at the end of the day, it's the most important investment criterion". THE MOST IMPORTANT INVESTMENT CRITERION. Our mission at Fundamental Edge is to train
the next generation of investors, and to specifically help young investors ramp up the mastery curve more rapidly. To do that successfully, we obviously must dive very deeply into what Lee called "the most important investment criterion".
We have a multi-module management evaluation framework that I will preview here and lay out in more detail in coming twitter threads, covering our: Management quality checklist Roadmap for management due diligence Bad CEO: "Deception, delusion & red flags"
Efficient use of management 1x1 meetings Activism 101 (bad CEO, meet frustrated shareholders) So now, a few high level thoughts on evaluating management. THERE IS NO ONE-SIZE-FITS ALL As with most things in investing, evaluating management is a highly personal decision
and frameworks should be developed that align with your strategy. VC and early stage tech investors should value strategic vision, technical mastery & personal charisma more than capital allocation expertise. The force of Elon's personality and clarity of his vision lowered
TSLA's cost of capital and kept the capital markets open during very precarious times for the company. Mature industries should value other characteristics. The railroad industry had a latent margin opportunity that was captured by Hunter Harrison's Precision Railroading concept
that was highly focused on execution and a new operational playbook for the industry. Sam Walton's simple mantra of "stack it high and sell it cheap", his ruthless execution and his down home sensibilities turned WMT into a juggernaut.
Buffett's singular focus on capital allocation. So first, be intellectually honest about what drives success with your investment approach. Does the company require a: VISIONARY: Who can sell a dream, raise equity capital (monetizing that dream) and attract a workforce who
believes in that dream? The "fake it 'till you make it" CEO, whose ability to raise capital actually manifests that dream. DEAL-MAKER: Who can adopt a private equity mindset to a public company, soberly adding value with consistent bolt on acquisitions. Transdigm, Constellation
Software, Danaher. Who is willing to sell/shutter underperforming divisions and apply a dispassionate lens to the structure of the business. EXECUTION WIZARD: Who can come in and raise margins by 500bps by simply blocking & tackling incredibly well. Cutting headcount,
renegotiating with suppliers and changing corporate culture around cost. CAPITAL ALLOCATOR: Who knows when to buy-back stock, acquire a competitor, pay down debt, applying an investor's lens to the allocation of the FCF production of the business. So first, when evaluating a
business, try to get very clear on what a business needs. In reality, CEOs all have some dose of each of these characteristics. But Elon couldn't run Berkshire and Warren couldn't run TSLA. Certain industries and situations require different management capabilities.
One of the best (and least reported) business successes that I have witnessed firsthand in my career is United Health's push into HC services via Optum (in my mind akin to AMZN's push into AWS). It required a vision
and relentless execution by management to enter these new markets. Top investors identified early that the core health benefits segment was reaching maturity and the company needed new avenues for growth. UNH management rose to the occasion. What UNH needed in 2010 is
different than what TSLA needed in 2008 or what the cigarette companies need now. So before evaluating management, attempt to evaluate the core issues and success determinants of the situation. Can the biz be run by a ham sandwich? I like to assess a CEO on 3 broad categories:
STRATEGIC. Does the CEO have the track record and ability to make big, strategic bets? OPERATIONAL. Is the CEO an "operational poet", turning complex operations into simple approaches supported with relentless execution? Shunning bureaucracy and conventional thinking in the
name of efficiency and value maximization. 3) FINANCIAL. Quite simply, does the CEO think like us? Does CEO deploy FCF the way we would, and find ways to do very attractive M&A deals. Does the CEO take care of the capital of the biz, or spend it freely in the name of empire
building. I will then translate these high level categories into a 6-step checklist: Integrity Intellectual honestly Independence of thought Incentive alignment Vision Execution In the future, I will dive more into frameworks to assess these 6 dimensions.
Stay tuned for more!