Sound management

Warren Buffett’s continuing theme

If there is one theme that continually runs through the public statements of
Warren Buffett it is the principle that investor should only consider for
investment companies with managers of competence and integrity.

What Warren Buffett looks for in company management

Warren Buffett has identified aspects of management that he looks for in
companies in which he invests. They include:

• Buy back of shares where the buy back is in the company’s interests, for example where the
  company has surplus funds and the shares can be bought back at less than intrinsic value

• Capability in allocation of capital

• Managers who stick to doing what the company does best; ‘the best business returns are
  usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.’

• Ability and readiness to tackle tough problems as they arise

• The use of retained profits to increase company profitability at beyond market rates

• A conservative approach to debt and liquidity
• Demonstrated ability to consistently grow company earnings and rates of return.

What Buffett does not like in company management

Warren Buffett has, throughout his career of public announcements, identified some things that
he does not like in company managers:

• Managers who pursue company acquisitions for reasons other than the good of the company – ego trips, the ‘institutional
  imperative’ of keeping up with other company acquirers, bad judges (they
  buy a toad and think that it will turn into a princess when they kiss it);
  as he famously said in 1981, ‘[M]any managerial [princes] remain serenely
  confident about the future potency of their kisses – even after their
  corporate backyards are knee-deep in unresponsive toads’.

• Managers who pursue growth for growth’s sake, irrespective of the value of that growth to the company

• Managers who expend too much of the company’s worth by issuing valuable shares to buy overvalued assets or who use debt
  to do so.

• Managers who enrich themselves at company expense by extravagant salaries and the abuse of share option
  arrangements

Good managers and bad businesses

Buffett does acknowledge that even the best managers will founder if the
business is not intrinsically sound. His most telling comment on management is:
'When a management with a reputation for brilliance tackles a business with a
reputation for poor fundamental economics, it is the reputation of the business
that remains intact.’

How can the average investor judge management?

The difficulty of course for the average investor is how to determine if a
company is soundly managed. Warren Buffett is a rich man and a big investor
and, while it is not known if he ever does this, he would be able to question
internal company management a lot easier than John Citizen.

The answer for the average investor is to extensively research a company
before investing and to ask the kind of questions that it seems Warren Buffett
asks before investing in a company.