Insider Buying and Management Stock Options Can Signal Opportunity

Only one reason for insider buying

In their search for complete information on businesses, investors often overlook one very important clue. In most instances no one understands a business and its prospects better than the management. 

Therefore investors should be encouraged when corporate insiders invest their own money alongside that of shareholders by purchasing stock in the open market. 

It is often said on Wall Street that there are many reasons why an insider might sell a stock (need for cash to pay taxes, expenses, etc.), but there is only one reason for buying. 

Investors can track insider buying and selling in any of several specialized publications, such as Vickers Stock Research. 

Management stock-options provide the specific incentive to boost the company's share price

The motivation of corporate management can be a very important force in determining the outcome of an investment. 

Some companies provide incentives for their managements with stock-option plans and related vehicles. 

Usually these plans give management the specific incentive to do what they can to boost the company’s share price. 

Be alert to the motivations of managements at the companies

While management does not control a company’s stock price, it can greatly influence the gap between share price and underlying value and over time can have a significant influence on value itself. 

If the management of a company were compensated based on revenues, total assets, or even net income, it might ignore share price while focusing on those indicators of corporate performance. 

If, however, management were provided incentives to maximize share price, it would focus its attention differently. 

• For example, the management of a company whose stock sold at $25 with an underlying value of $50 could almost certainly boost the market price by announcing a spinoff, recapitalization, or asset sale, with the result of narrowing the gap between share price and underlying value. 
• The repurchase of shares on the open market at $25 would likely give a boost to the share price as well as causing the underlying value of remaining shares to increase above $50. 

Obviously investors need to be alert to the motivations of managements at the companies in which they invest.

Careful Investors look for Signs of Quality Management

One of the main factors determining the success of a corporation is the competence of management.

Buy into companies with "good management."


But in practice, how do you know?

• Ideally you begin by meeting management.  However, the door is open to very few and the ability to assess it is just as limited.
• The practical approach is to begin by looking at the record.

Practical Approach:  Looking at the Record

If a company's earnings are increasing, this is one piece of evidence pointing to good management.

• However, the results must be measured against others in the same industry.  
• Otherwise, a management which swims with a favourable tide may get more credit than it deserves.  

Often a superior management fighting bad conditions is unjustly criticized.


Type of Management Counts

Is the company in question headed by an old-fashioned entrepreneur who has made management a one-man show?

Or does it have good management in echelon depth which can survive the retirement or death of its chief executive?


Officers' shareholdings

One aspect of management worth noting is the extent to which the officers own their own shares.

Broadly speaking, it is advantageous for the officers to have a stake in ownership.

It makes a difference whether they own the stock

• because they want it or 
• because they are stuck with it.

You should consider whether they

• acquired it through inheritance, 
• bought it on option, or 
• bought it in the open market.  

Likewise, where possible, consider the purchase date and price paid.



Close Watch Pays Off

One of the many ways of making money in securities, is through a close watch on management.

Watch and understand the changes where companies have been in difficulty, their stocks depressed and general dissatisfaction expressed and where a new management comes in and invariably begins by sweeping out the accounting cobwebs.

• Everything is marked down or written off so that the new management is not held accountable for the mistakes of the old.  
• Very often dividends which were imprudently paid are cut or passed.  
• Thus an investor at this juncture often gets in at the bottom or the beginning of a new cycle.
• A recent example:  TESCO London.

Conclusion:

Attempting to evaluate management, even though you cannot get all the answers, is worth all the effort it entails.



Related post:

Management Compensation
https://myinvestingnotes.blogspot.com/2010/04/buffett-1994-in-setting-compensation-we.html

How to judge the Evaluate of Management?

https://blog.elearnmarkets.com/how-to-evaluate-management-of-a-company/

Better Investor Communications

Managers should communicate with investors to help align the value of the stock with the intrinsic value of the company.

Negative consequences of an underpriced stocks

If the stock is underpriced, a few of the negative consequence are that:

• employees may be demoralized, 
• the stock is less useful in stock acquisitions, and 
• the firm may become a takeover target.

Negative consequences of an overpriced stocks

If the stock is overpriced, the price will eventually fall, which will lead to:

• a fall in employee morale and 
• increased tension between the board of directors and the managers.
• Also, once the stock is overpriced, managers may engage in value-destroying activities in an attempt to prop up the stock price.

How can companies improve investor communications?

Three ways many companies can improve investor communications are to:

1. monitor the gap between price and intrinsic value,
2. understand the investor base, and 
3. tailor communications to the investors who matter most.

In general, the managers should try to communicate with sophisticated intrinsic investors because the activities of these investors have the most impact on the price of the stock.

Managers should be honest and not use gimmicks such as changing the metrics reported each period to give the most favourable numbers.

How useful is earnings guidance?

Earnings guidance does not provide any discernible benefits.

Performance management systems.

These systems align decisions with short- and long-term objectives and the overall strategy.

Such systems typically include:

• long-term strategic plans,
• short-term budgets,
• capital budgeting systems,
• performance reporting and reviews, and 
• compensation frameworks.

The rigor and honesty of implementing the system is at least as important as the system itself.

Implementing the system includes

• choosing the metrics, 
• composing the scorecard, and 
• setting the meeting calendars.

1.  Choosing the right metrics

Choosing the right metrics means identifying the value drivers.

Typically the ultimate drivers are

• long-term growth,
• ROIC, and
• the cost of capital.

Short- , medium-, and long-term value drivers determine growth, ROIC and the cost of capital.


Short-term value drivers

Short-term value drivers are usually the easiest to quantify, and examples include

• sales productivity,
• operating cost productivity, and 
• capital productivity.

Medium-term value drivers

Medium-term value drivers consist of

• measures of commercial health, 
• cost structure health, and 
• asset health.

Long-term value drivers

Long-term value drivers address strategic issues such as

• ways to exploit new growth areas and 
• the existence of potential market threats.

Understanding the value drivers allows the managers to have a common language for their goals and to make better choices of trade-offs between critical and less critical drivers.


2.  Composing the Scorecard


Balanced scorecard approach

This was introduced by Robert S. Kaplan and David P. Norton in "The Balanced Scorecard:  Measures That Drive Performance" (Harvard Business Review, February 1992).

This approach can reflect many aspects of the firm and its goals.

The choice of critical drivers should be tailored to the firm's businesses.



A tree based on profit-and-loss structure approach

This is often the most natural and easiest to complete.

The targets need to be challenging and realistic, however, and should not consist of only a single point.

One recommendation is the use of base and stretch targets, where achieving the latter reaps a reward for the manager and not a penalty.



3.  Organizational Health

In addition to determining the drivers and targets, managers should assess organizational health, which is determined by

• the people, 
• skills and 
• culture of the company.

Managers should help set the targets to better understand these issues.

Fact-based reviews with appropriate rewards should depend on:

• stock performance where macroeconomic and industry trends have been removed,
• long-term assessments that might mean deferring rewards, and 
• measures of performance against both quantitative and qualitative drivers.

The firm should harness the power of nonfinancial incentives, such as creating a culture that attracts and motivates quality employees.

The Five Rules for Successful Stock Investing 8

Analyzing a Company – Management

Excellent management can make the difference between a mediocre business and an outstanding one, and poor management can run even a great business into the ground. Your goal is to find management teams that think like shareholders – executives that treat the business as if they owned a piece of it, rather than as hired hands.

Executives' pay should rise and fall based on the performance of the company. [...] Firms with good corporate governance standards won't hesitate to pay managers less in bad times and more in good times, and that's the kind of pattern you want to see as a shareholder.

http://books.danielhofstetter.com/the-five-rules-for-successful-stock-investing/

The Five Rules for Successful Stock Investing 7

Analyzing a Company – The Basics

Because [analyzing companies] can be a daunting task, I suggest that you break down the process into five areas:

1. Growth: How fast has the company grown, what are the sources of its growth, and how sustainable is that growth likely to be?
2. Profitability: What kind of returns does the company generate on the capital it invests?
3. Financial health: How solid is the firm's financial footing?
4. Risks/bear case: What are the risks to your investment case? There are excellent reasons not to invest in even the best-looking firms. Make sure you look at the full story and investigate the negatives as well as the positives.
5. Management: Who's running the show? Are they running the company for the benefits of shareholders or themselves?

You can't just look at a series of past growth rates and assume that they'll predict the future [...]. It's critical to investigate the sources of a company's growth rate and assess the quality of the growth. High-quality growth that comes from selling more goods and entering new markets is more sustainable than low-quality growth that's generated by cost-cutting or accounting tricks.

In the long run, sales growth drives earnings growth. Although profit growth can outpace sales growth for a while if a company is able to do an excellent job cutting costs or fiddling with the financial statements, this kind of situation simply isn't sustainable over the long haul – there's a limit to how much costs can be cut, and there are only so many financial tricks that companies can use to boost the bottom line. In general, sales growth stems from one of four areas:

1. Selling more goods or services
2. Raising prices
3. Selling new goods or services
4. Buying another company

If you don't know how fast the company would have grown without acquisitions, don't buy the shares – because you never know when the acquisitions will stop. Remember, the goal of a successful investor is to buy great businesses, not successful merger and acquisition machines.

The first component of ROA (Return on Assets) is simply net margin, or net income divided by sales, and it tells us how much of each dollar of sales a company keeps as earnings after paying all the costs of doing business. The second component is asset turnover, or sales divided by assets, which tells us roughly how efficient a firm is at generating revenue from each dollar of assets. Multiply these two together, and you have return on assets, which is simply the amount of profits that a company is able to generate per dollar of assets. Think of ROA as a measure of efficiency. Companies with high ROAs are better at translating assets into profits.

ROA helps us understand that there are two routes to excellent operational profitability: You can charge high prices for your products (high margins), or you can turn over your assets quickly.

Return on equity (ROE) is a great overall measure of a company's profitability because it measures the efficiency with which a company uses shareholders' equity – in other words, it measures how good the company is at earning a decent return on the shareholder's money.

http://books.danielhofstetter.com/the-five-rules-for-successful-stock-investing/

Cut Your Problems Down to Size

One of the easiest habits to fall into as a business owner is to group individual problems into big buckets like ‘I can’t get my team on board’. That might be true, but by thinking about it in this way, you've advertently put the problem in a frame that you can’t really work on. Instead, get in the habit of turning those buckets upside down, by pulling apart and dealing with the individual frustrations that are at the root. You'll start seeing opportunities to make small but definitive changes throughout the day, changes that will add up to big results over time.

Here’s a way to ‘un-bucket’ the three most common problems you have so you can work on them a little bit every day (if you think about it, you might only have these three problems).

"People Problems": If you have a pattern of personnel issues, the sensible part of you knows you’re contributing to them because of your blind spots (they’re not called that by accident). You can’t discover and change all of them overnight. But you can start by challenging them in individual relationships. 

-   For example, you can resist the urge to jump in and save someone on your staff who has a tough task to complete and leave them room to grow. 

-  Or you could start a personal conversation with someone on your team that you’ve kept at a distance.

"Money Problems": The easiest way to start turning your money problems around is to find one expense—right now—that you don’t really need. I guarantee there are 10 of them, but you can’t—and shouldn’t—cancel all 10 at once. Cancel one. Prove to yourself that you don’t need it. Next week, cancel another. Imagine how much money you’ll be saving 10 weeks from now.

"There’s Not Enough Time": The problem isn’t too little time. It’s that you have too many ideas—which results in a lack of head space to execute on the right ones. The unchecked entrepreneur in you is more comfortable coming up with a new idea than confronting a current issue. Delete one project (and I mean delete it from your task list—including all the emails, notes, etc.). Make an announcement telling everyone on the team to do the same. Imagine what it would feel like if everyone in your business was working on one, and only one, goal right now.

You’ll quickly discover how liberating it can be to do just one of these each week. Your team will be grateful, your profitability will improve, and you’ll drive home feeling like you got something done each day. After a few weeks like that, you’ll be hooked.

Jonathan Raymond   April 22, 2015

http://blog.emyth.com/cut-your-problems-down-to-size

Asset value (AV) and Earnings power value (EPV). Know the 3 scenarios - AV > EPV, AV = EPV and AV < EPV

What you have got then is two pictures of value: 

1. You have got an asset value
 2. You have got an earnings power value
 
And now you are ready to do a serious analysis of value. If the picture looks like case A (AV > EPV), what is going on assuming, you have done the right valuation here? If it is an industry in decline, make sure you haven’t done a reproduction value when you should be doing a liquidation value.  What it means is say you have $4 billion in assets here that is producing an equivalent earnings power value of $2 billion. What is going there if that in the situation you see?  It has got to be bad management.  Management is using those assets in a way that can not generate a comparable level of distributable earnings.  

AV is Greater Than EPV 

• In this case the critical issue—it would be nice if you could buy the company—but typically you pay the reduced EPV and all that AV is sitting there.
• Then you are going to be spending your time reading the proxies and concentrating on the stability or hopefully the lack of stability of management. 
• Preeminently in that situation, the issue is a management issue. 
• The nice thing about the valuation approach is that it tells you the current cost that management is imposing in terms of lost value.  That is not something that is revealed by a DCF analysis. And there are a whole class of value investments like that.
• One of the great contributions to the theory of this business is Mario Gabelli’s idea that really what you want to look for in this case is a catalyst that will surface the true asset value.
• You can wait and sometimes that catalyst may be Michael Price or Mario Gabelli if they own enough of the company.  I would like to encourage those investors who are big enough to make that catalyst you.  

AV Equals EPV 

• The second situation where the AV, the reproduction value of the assets = EPV are essentially the same.
• That tells a story like any income statement or balance sheet tells a story.  It tells a story of an industry that is in balance.  
• It is exactly what you would expect to see if there were no barriers-to- entry. 
• And if you look at this picture and then you analyze the nature of the industry—if you say, for example, this is the rag trade and I know there are no competitive advantages—you now have two good observations on the value of that company. 
• If it ever were to sell at a market price down here, you know that is what you would be getting. You are getting a bargain from two perspectives: both from AV & EPV so buy it. 

EPV in Excess of AV 

• We have ignored the growth, but I will talk about it in a second#. The last case is the one we really first talked about. You have got EPV in excess of AV. 
• The critical issue there is, especially if you are buying the EPV—is that EPV sustainable?
• That requires an effective analysis of how to think about competitive advantages in the industry.

Introduction to a Value Investing Process by Bruce Greenblatt at the Value Investing Class Columbia Business School 
Edited by John Chew at Aldridge56@aol.com                           
studying/teaching/investing Page 26

 Notes from video lecture by Prof Bruce Greenwald
http://csinvesting.org/wp-content/uploads/2012/06/greenwald-vi-process-foundation_final.pdf



Related topic: #
Look at growth from the perspective of investment required to support the growth. Profitable Growth Occurs Only Within a Franchise.

How then do you assess management quality?

Those in management should have integrity, intelligence and also must be hardworking.  Most importantly, they should have integrity.  Search and look for integrity in the managers; without this, their intelligence and hardworking will work against the interest of the shareholders.

In present day perspective, the shareholders and the management interests are linked or in conflict mainly in two principal areas of:

(1)  competence of management and,
(2)  policies of management toward stockholders - notably in the matter ofdividends.

What are your views of companies hoarding cash aplenty when perhaps, the better decision is to distribute the cash to the shareholders in dividends or share buy-backs?

Buffett allocates funds in ways that build per share intrinsic value.

At Berkshire, our managers will continue to earn extraordinary returns from what appear to be ordinary businesses.  As a first step, these managers will look for ways to deploy their earnings advantageously in their businesses.  What's left, they send to Charlie and me.  We then try to use those funds in ways that build per-share intrinsic value.  Our goal is to acquire either part or all of businesses that we believe we understand, that have good, sustainable underlying economics, and that are run by managers whom we like, admire and trust.

The First Secret of Small-Cap Investing: DEMAND PROOF OF MANAGERIAL EXCELLENCE

Great businesses are made, not born. And the secret to making a great business is having solid leadership in place — a management team that can drive a company on the route to sustainable excellence.

As with any stock investment, it’s imperative to establish that a small company’s leaders are more than competent — they have the skill and expertise to deliver profits to shareholders. Although there are many ways to determine whether a company’s management team is up to the task, a few factors rise to the top.

First, a company should have an operating history of at least three years. For companies that have recently gone public, this period could include years before its initial offering. There should have been no jarring changes of management during the company’s recent past as well. A company’s management can’t be evaluated without evidence, so the team responsible for the success of the venture to date must still be in place in order to make judgments.

Second, a company must be profitable to be considered for investment. The promise of future profits is not sufficient. Nor is it enough for a company to have recently turned the corner and posted positive earnings for the first time in its history. If a company has been able to deliver several recent years of profitability, management has passed the most important test of its skills.

But it’s not enough that a business’s management is merely competent. Our third suggestion is that stock investors strive for excellence — seek companies that meet or surpass the performance measures of their peers and competitors.

Fourth, the strength and consistency of historical growth is certainly area where investors can discern the hand of management in building a business poised for long-term future success.

Fifth, the trend and level of a company‘s pretax profit margins is perhaps the single most important comparative factor. Successful, quality companies can be identified by the margins they eke out on each dollar of revenue. Higher margins than competitors are almost always a sign of management expertise. Relatively stable annual margins are demanded of all companies. Growing margins are a positive.

To be sure, smaller companies may be in the phase of building their business, investing now to support greater success in the future, so the analysis of margins when compared with more established competitors should keep this possibility in mind.

A company’s return on equity should be reviewed carefully, but this measure not be less useful as a quality consideration for newer-stage businesses. Smaller companies can earn higher returns on initial equity, but these levels are not sustainable. Caution must again be exercised when comparing small businesses with established enterprises. Finally, any company included in a growth stock portfolio must have identifiable drivers of future growth. Tailwinds should be stronger than headwinds. No business can coast to success on the coattails of its past success, so management must be able to present a viable vision for how it intends to grow the business in the years ahead.

http://blog.betterinvesting.org/?p=2417

How Management Affects Moats - Morningstar Video

Is Management in Your Corner?

Morningstar's new Stewardship Ratings for stocks can help reveal if management teams are working in shareholders' best interests or just their own.

http://www.morningstar.com/Cover/videoCenter.aspx?id=548155

Value Investing Tips - How to Assess a Company's Management

Good managements produce a good average market price, and bad managements produce bad market prices.

Market Price Fluctuations:  An Added Consideration

Something should be said about the significance of average market prices as a measure of managerial competence. 

• The shareholder judges whether his own investment has been successful in terms both of dividends received and of the long-range trend of the average market value. 
• The same criteria should logically be applied in testing the effectiveness of a company’s management and the soundness of its attitude toward the owners of the business.

This statement may sound like a truism, but it needs to be emphasized.

• For as yet there is no accepted technique or approach by which management is brought to the bar of market opinion. 

On the contrary, managements have always insisted that they have no responsibility of any kind for what happens to the market value of their shares.

• It is true, of course, that they are not accountable for those fluctuations in price which, as we have been insisting, bear no relationship to underlying conditions and values. 
• But it is only the lack of alertness and intelligence among the rank and file of shareholders that permits this immunity to extend to the entire realm of market quotations, including the permanent establishment of a depreciated and unsatisfactory price level. 

Good managements produce a good average market price, and bad managements produce bad market prices.

What Warren Buffett Looks for in Company Management

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 with extravagant salaries and the abuse of share option arrangements

Sound Management: HOW CAN THE AVERAGE INVESTOR JUDGE 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.

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.

Evaluating Company Management in Fundamental Analysis

Evaluating Company Management in Fundamental Analysis
BY STOCK RESEARCH PRO • APRIL 21ST, 2009

When evaluating a stock, many investors will look at the strength and effectiveness of company management as part of the due diligence process. The corporate scandals of recent years have reminded all of us of the importance of having a high-quality management team in place. The role of the management team, as far as investors are concerned, is to create value for the shareholders. While most investors see the significance of strong management, assessing the competence of an executive team can be difficult.

The Role of Company Management
A strong management team is critical to the success of any company. These are the people who develop the ongoing vision of the company and make strategic decisions to support that vision. While it can be said that every employee brings value, it is the management team that “steers the ship” through competitive, economic and the other pressures associated with running a company. In measuring the effectiveness of the management team the investor is able to determine how well the company is performing relative to its industry competitors and the market as a whole.

Assessing Management Performance
Some of the metrics a fundamental investor might use in measuring the effectiveness of company management might include:
Return on Assets: The ROA provides an indication of company profitability in relation to its total assets. Part of effective company management is the efficient leverage of company assets to produce earnings.

A Return on Assets Calculator

Return on Equity: The ROE measures net income as a percentage of shareholders equity. For shareholders, the ROE provides a means of measuring company profitability against how much they have invested. The ROE is best used to compare the profitability of the company (and company management, by extension) with other companies in the industry.

A Return on Equity Calculator

Return on Investment: The ROI measures the effective use of debt for the benefit of the company. Skillful use of debt resources by company management can play a significant role in the growth and prosperity of the company.


http://www.stockresearchpro.com/evaluating-company-management-in-fundamental-analysis

Bullbear Stock Investing Notes
http://myinvestingnotes.blogspot.com/

Managing the various structural units of a Company

Zech Management GmbH is the main service company in the Zech Group. The team of around 90 employees provides a variety of services on behalf of the parent company, Zech Group GmbH, as well as for the operating companies.

Zech Management discharges the controlling and steering functions. It supervises, for example, the strategy and the agreed-upon targets. Zech Management coordinates activities in the various fields of business and of the operating units. The following areas or sections are integrated in Zech Management:

Controlling
Accountancy, Financial Statements and Taxation
Financing and Cash Management
Group Financial Statements and Company Planning
Mergers & Acquisitions
Personnel
Insurance
IT (Information Technology) and Organization
Corporate Communications and Public Relations
Internal Audits (in preparation)
Central Services
Corporate Governance, Corporate Compliance and Code of Conduct
The company is headquartered in Bremen. Zech Management GmbH reports to Zech Group GmbH.