Value investors can spend a lot of time evaluating the quality of a company's management. We look at management's track record, and attempt to gauge the level of management's candor in providing information to shareholders.
But when it comes to companies that trade at large discounts to their net assets, is this exercise worthwhile? Thanks to our capitalist system, managers who are not getting the most out of company assets will often be replaced, a process which can often serve as the catalyst that helps a stock's price converge with its intrinsic value. By avoiding the companies with poorly performing managers, shareholders may be missing out on the potential for large gains.
This article was written by Saj Karsan of Barel Karsan. If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.
Consider RCM Technologies (RCMT), a company we discussed about a year ago as one that traded at a deep discount to its net assets despite a flexible cost structure and therefore a decent earnings outlook. Nevertheless, management's poor capital allocation decisions in the past and their seeming intentions to continue to "build empires" had us avoiding the company.
But those who were willing to take the plunge despite the management situation would be rewarded. The company recently received a buy-out offer at a price which is about twice that of what it was when we looked at it last August. This is a classic case of getting rewarded for buying assets for less than they are worth.
For companies expected/required to generate above-average returns on capital, the management team is likely a very important factor in determining whether the investment makes sense. But perhaps we place too much emphasis on the management team when it comes to companies trading at large discounts to their assets. After all, management teams can be replaced, and shareholders can get rewarded in the process. On the other hand, buyouts are difficult to predict and may not occur with enough frequency to remove every poorly performing management in a timely manner.
The right decision is not always clear, but investors should keep in mind that the importance placed on the management team in weighing an investment decision may change according to the type of investment (e.g. an earnings play vs an asset play) being made.
Disclosure: None
I bought BP shares this past week. In some ways the decision was dead easy, in other ways I must admit that I am still questioning my choice- but not for the regular reasons. Let me explain to you first why it was an easy decision (my rational side) and then lets talk about why it was a tough decision (let's call it my emotional side).
