Assessing Management Quality, The Warren Buffett Way
On being asked by management students who visited his office in 2005 as to what are the first things he looks for in a management team, here was what Warren Buffett told them...
...you look for the logical things—passion, an interest in running the business, honesty. Such as, do they love the business, or do they love the money?
This is the first filter. I mean real passion.
Buffett then talked about Rose Blumkin (Mrs B), a penniless Russian immigrant who came to the United States in her early 20s, founded Nebraska Furniture Mart at age 44 in 1937 with a $500 loan from her brother and money she had saved from selling used clothing, and ran the store until she died at the age of 104, in process turning it into an enterprise worth over $1 billion.
Her business motto was, “Sell Cheap, Tell The Truth, Don’t Cheat Nobody.”
Buffett had enormous respect for what Mrs B had achieved and he wanted to buy her store. He asked if she would consider selling it and when she said, “Yes,” he asked how much she wanted.
“$60 million,” replied Mrs B, and she agreed to sell 90 percent, with her family retaining 10 percent. Because of his respect for her integrity and her business acumen, Buffett made this offer without auditing her books or inventory. Tax returns showed the business made $15 million a year in profit before tax and that was fine for Buffett.
He had a one-page agreement prepared and Mrs B, who could barely read English and did not write in it, made a mark at the bottom to signify her approval.
“That's passion,” Buffett told students after recounting Mrs B’s story. “If temperament is the most important personal asset in managing money, in business, it’s passion.”
He then talked about the other important aspect he looks at in the management—
Secondarily, if you’ve been doing it a while, you get to know how to do it. But obviously no management team is perfect, so you’re often stuck making a judgment call. You don’t want to wait forever to find the perfect team.
Incidentally, a friend of mine spent twenty years looking for the perfect woman; unfortunately, when he found her he discovered that she was looking for the perfect man.
Here are two very important lessons from Buffett—
One, look for managers who have the passion to run their businesses. The danger here is that some managers are so passionate that they lose the sense of what’s right and what’s not when it comes to ethical standards in running their affairs. For example, Bernie Madoff was a passionate businessman and so was Ramalinga Raju, and so are so many other managers who lever up their balance sheets to grow their businesses bigger and faster than their competitors. Just that managers like these use their passion to cheat people and/or hurt stakeholders in the long run.
On the contrary, there are countless known and unknown managers who have worked passionately and honestly to serve the interests of all stakeholders well over years and years of managing their businesses. People that come top of mind here are those managing businesses like Asian Paints Ltd., Pidilite Industries Ltd., Marico Ltd., Infosys Ltd., Tata Consultancy Services Ltd., Wipro Ltd., Housing Development Finance Corporation Ltd., and Bajaj, Hero and Coromandel groups.
As for the Tatas specifically, I would certainly put them in the passionate-cum-honest category. But they have gone overboard in terms of passion in some of their large businesses like Tata Steel Ltd. and Tata Motors Ltd., which they tried to grow aggressively and inorganically, and ended up leveraging their balance sheets enough to destroy shareholder value over some years.
The second lesson I derive from Buffett here is that we must not try to aim just for perfect managers, because they don’t make them anymore.
Managers are very much humans like all of us reading this article (except bots and aliens!), and they suffer from their biases and other behavioural issues when it comes to decision-making. They make their share of mistakes. Some also, despite acting ethically most of the times, seldom play near the baselines.
Like Buffett says, “…obviously no management team is perfect,” and that’s not what we should be searching for. Look only for lesser evils.
Now, where should you search for such managers?
- Look at their past track record in running their business (longer track record is better, and in terms of business growth and profitability, on an absolute basis and vis-à-vis competitors), as a long track record of successfully/unsuccessfully managing a business raises the odds the this would be repeated in the future too,
- How well or badly they have allocated capital (return on capital, return on equity),
- How much is the balance sheet leveraged (more debt isn’t good anyway),
- How aggressive they have been on the acquisitions front (shun the aggressive ones),
- Have they indulged in any insider trading activity (Google for “insider trading+company name”). Have the senior managers been buying or selling the company’s stock,
- Have they been associated with any other scams of any kind in the past (Google for “scam/fraud+company name”),
- How are senior managers compensated, and,
- Is the CEO self-promoting (my thumb rule is to check if they appear in media more than once in a month)
- Like Buffett asked, assess if the managers love the business, or the money.
You see, most of us overlook the human aspect of operating a business, yet, in most cases, the future success of a business is directly tied to the quality of the people managing its affairs. Now, as an outside investor, you cannot know every detail of what’s going on inside a manager’s mind and what all he or she is doing while managing the operations.
That’s why it’s important to get a big-picture idea of the managers (passion + experience + honesty on a broader scale), and then choose the ‘nearly perfect’ ones.
Vishal Khandelwal is the founder of SafalNiveshak.com, an initiative to help people learn the art of value investing and behavioural finance to be able to make better investment decisions.
The views expressed here are those of the author and do not necessarily represent the views of Bloomberg Quint or its editorial team.