Value Investing and Company Management

The management factor, while significant, also poses certain challenges that make its evaluation better suited to the activities of professional investors.

Warren Buffett

From Warren Buffett's 2010 FCIC interview:

"I’ve also said many times in reports and elsewhere that when a management with reputation for brilliance gets hooked up with a business with a reputation for bad economics, it’s the reputation of the business that remains intact.

If you’ve got a good enough business, if you have a monopoly newspaper, if you have a network television station — I’m talking of the past — you know, your idiot nephew could run it. And if you’ve got a really good business, it doesn’t make any difference.

I mean, it makes some difference maybe in capital allocation or something of the sort, but the extraordinary business does not require good management."

In short, what Buffett is saying here is that the facts and figures pertaining to a company are far more reliable indicators of its investment merit than assessments of its management. This is quite similar to what Seth Klarman has said on the subject and is covered in the next section.

Buffett also expressed another classic Value Investing principle in his usual succinct manner during the same interview:

Brad Bondi: "Have you sent any letters or submitted any memos or ideas for strategy decisions at Moody’s?"

Warren Buffett: "If I thought they needed me, I wouldn’t have bought the stock."

Seth Klarman

From Seth Klarman's preface to Graham's book, Security Analysis:

"Investors also expend considerable effort attempting to assess the quality of a company's management. Some managers are more capable or scrupulous than others, and some may be able to manage certain businesses and environments better than others. Yet, as Graham and Dodd noted, "Objective tests of managerial ability are few and far from scientific.""

Klarman's comments are self explanatory. The management factor may be important for an investment, but there are few reliable ways of estimating it.

Benjamin Graham

Graham — Buffett's mentor — gives more detailed explanations of why the management factor is not usually considered during investment analysis despite being a significant factor in the running of any enterprise.

"It is fair to assume that an outstandingly successful company has unusually good management. This will have shown itself already in the past record; it will show up again in the estimates for the next five years, and once more in the previously discussed factor of long-term prospects. The tendency to count it still another time as a separate bullish consideration can easily lead to expensive overvaluations. The management factor is most useful, we think, in those cases in which a recent change has taken place that has not yet had the time to show its significance in the actual figures."

Graham also dedicates an entire chapter of The Intelligent Investor to the shareholder-management relationship.

"It can be stated as a rule with very few exceptions that poor managements are not changed by action of the “public stockholders,” but only by the assertion of control by an individual or compact group. "

Acquisition Vs Investment

Buffett says that the management factor is mostly relevant in acquisitions, and that most marketable securities can be understood simply by reading their annual reports.

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