Warren Buffett: How to Properly Evaluate a Company’s Management

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This video is on a topic that is extremely important but rarely gets the attention it deserves: How to properly evaluate a company’s management. This is the one thing in investing that can be the difference between a great investment and an investment that loses you money. The more time I spend investing, the more I come to appreciate just how important a company’s management is in the overall success of your investment. All of this information is completely free, the only cost is that you have to hit the like button. Seriously, that’s it, all you have to do is hit the like button. Now, let’s jump in.

In my job as an investment analyst at a large investment fund, I spend a lot of time meeting a company’s management and talking to the CEO of the company I’m looking to invest in to get a better sense of the quality of the management. However, as Buffett said in the clip, you don’t have to ever talk to a CEO to get a sense of just how good a company’s management is. The answer is in the annual reports and interviews a CEO gives. Here are 4 things Buffett recommends looking for when judging the management of the company. But first, if you are interested in following my own personal portfolio and hearing my thoughts on the market, download the investing app, Public, using the link in the description. By using the link and depositing as little as $1, you get a free slice of stock of your choosing, up to $70. It’s literally free money. Now let’s get back into the video.

A management that is willing to admit their mistakes. This is a sign of a high integrity management too. Buffett walks the talk on this criteria. For those of you that didn’t know, In addition to being a great investor, Buffett is also the CEO of Berkshire Hathaway. When I first started learning about Buffett, I was surprised at how freely he was willing to admit mistakes in his annual reports. Look no farther than his most recent annual letter. Buffett admitted in this report that a mistake he made led to an $11 billion loss in 2020, even as profits continued to rise in the businesses Berkshrie owns. Buffett wrote that Berkshire had to write down the value of Precision Castparts, a manufacturer that makes parts for aerospace and defense companies, accounting for almost all of the loss. Buffett said, “I paid too much for the company,” “No one misled me in any way – I was simply too optimistic about Precision Castparts’s normalized profit potential…last year, my miscalculation was laid bare by adverse developments throughout the aerospace industry, Precision Castparts’ most important source of customers.”

A management that provides you with the information you need to correctly evaluate the business and its growth strategy. This is so important because it gives a concrete way for you to evaluate the success or failure of a management team in relation to their goals. Here’s an example of this from a company I have recently been doing some research on. This company is Carvana; let’s take a look at their annual report. Carvana’s CEO clearly lays out what the most important metrics are to evaluate a business and how the company plans to grow moving forward. When you open up Carvana’s annual report, one of the first pages is the key metrics in evaluating the success of the business. Not only do they clearly show the current year figures but also historicals so you can easily see the progress, or potential lack of progress, in evaluating the company’s progress against these key metrics. They aren’t trying to hide the numbers, they are putting the numbers in bold and color at the front of the report for all investors to see and make judgements on. Shareholders can them hold them accountable based upon those figure.
The next important thing you want to look for is a management that has allocated capital successfully in the past. I know the term “allocating capital” seems advanced and can be a little intimidating, but put simply, it is looking at what a company’s management did with all of the cash the business generated. There’s a big potential red flag you potentially want to avoid here. It’s likely a good idea to avoid management teams that have been involved in failed acquisitions, meaning the CEO decided to buy another company and the purchased company either wasn’t successful or the CEO paid too much for that purchase. Poor acquisitions are one of the quickest ways a management team can hurt shareholders.

Another important thing to look for is a management that has the proper long term compensation structure. A compensation structure, simply put, is how the CEO is paid. A CEO should be compensated based on the key metrics that we talked about earlier and not necessarily just on short term stock performance. Additionally, it’s good when a CEO owns a large amount of stock in the company.