TALKING WITH MANAGEMENT
Informed investing requires careful study of company financial data, an understanding of industry trends and market psychology, a little luck, enormous patience, independent thinking, and helpful contacts. While most of us would agree with this list, the definition of "helpful contacts" remains elusive. As a result, newspaper or magazine articles, hot tips, and friends' recommendations account for more buy and sell decisions than meticulous research. We spend months seeking out data to determine the best $500 washing machine, but are willing to invest $5000 on a "can't lose" speculation overheard by a "helpful contact" at a cocktail party.
The most useful contacts are typically our most knowledgeable investors--company management. These insiders have more information about their companies than any outside analyst or annual report can possibly convey. But they are also among the most under-utilized sources of information by individual investors. Therefore it seems worth discussing some of the fundamental aspects of talking with management. Contrary to popular belief, while you may have trouble contacting the CEO at AT&T, small cap companies' officers are usually quite willing to talk with you, and it is often possible, over time, to develop a personal relationship with management.
Do Your Homework
Part of management's job involves talking with investors. But company executives are just as busy as you and I; experience suggests that their receptivity to your calls is contingent on several factors. First, they want to feel that you've done your homework and that you know something about their company. That means that you've read the latest 10Q or 10K, annual report and proxy statement, that you are familiar with their product or service, and aware of their latest press releases.
Formulate Specific Questions
Second, they appreciate hearing that you have specific questions which have been generated by your interest in the company (e.g. "I noticed in your last quarterly report that inventories are significantly higher than last year, and I couldn't figure out why; could you help me out with that?" Initially, specific questions help management feel more comfortable talking with you than vague inquiries such as "Where do you think the stock price is headed?" or "How are things going this year?" Once the specifics are answered and management has a better sense of you, it's much easier for them to add some general positives or negatives about the company.
Genuine Interest
Third, management is much more receptive if you are truly interested in their company rather than if you are calling to challenge every statement in their latest Annual Report. An adversarial stance will usually inhibit a relatively free discussion. Your general approach to contact with management should be one of an inquisitive investor who is interested in buying part of the business. Try to experience the conversation from the management's vantagepoint. For example, in this day and age of litigious shareholders, management will be reticent to make any specific predictions or statements that could lead to a class action lawsuit that would disrupt the functioning of the company. Expect some hesitation at first, but don't be put off by it.
If Management Won't Talk With You, Don't Invest
Any management representative not willing to talk with you or respond to your questions should raise an immediate warning flag. If the front line perceives shareholders as threatening, you can be sure that increasing shareholder value is not a priority. I once was very interested in recommending a small cap company for my Newsletter and telephoned management with my questions. When Investor Relations refused to answer the inquiries, I asked to be put through to the CFO, who promptly told me that he did not make a habit of discussing his company's prospects with shareholders. Needless to say, I did not recommend the stock, which in the next two months, dropped 90%! Refusal of any public company to talk with its shareholders is always an ominous sign.
Where To Begin
Whenever you're considering investing in a micro-cap company, remember that patience is always worth more than money. If XYZ Corporation is a good investment this week, it will be equally suitable next week. Before committing any money, call the company and ask for Investor Relations. Ask them to send you a complete financial package and to add your name to their mailing list. This request assures that you will receive all quarterly and annual reports and press releases in a timely fashion.
This call initiates the first part of your assessment. How do they respond to your call? Do they send you the material in a timely fashion (two weeks)? If not, be wary and ask for an explanation. While a courteous and prompt response does not insure anything, a company that does not execute a simple request for information may well have difficulty executing major plans for growth and expansion.
After you have read the financial packet, you may want to do some research into trends within the industry in which the company operates. It is also helpful to become familiar with the company's largest customers and competitors; and don't hesitate to call either to elicit their reactions to your prospective investment.
QUESTIONS FOR MANAGEMENT:
As a result of reading the 10 Q's and 10 K's (the reports which the company is required to submit to the SEC), you should be able to formulate a few specific questions for management to answer. You are now in a position to call the company. Ask to speak with the CFO or CEO. Tell them that you are a prospective investor who is very interested in the company, have read their financial package, and have some questions which you would like help in answering. In terms of your assessment, you are listening here not only for the answers to your questions, but more importantly, for the quality of their response to your interest--whether they seem to welcome curiosity about their products, ways of doing business, etc., and how willing they are to share their thoughts with you.
Is Management a Good Technician?
After your specific questions are answered (why the slow down in sales, or the increase in operating expenses, or the rise in inventories, etc), it is helpful to ask a series of more general questions. In the annual report, there is always a letter to shareholders outlining future directions of the company. While most investors consider this glossy page to be nothing more than fluff, it allows you to question management about their written future directions. Have they completed whatever projects they outlined for the following year? If not, why not? You are listening here for whether management can follow through on their promises to shareholders. In other words, is management a good technician? Can they follow through with promised goals that will enhance growth?
Management Interaction
I usually like to ask whomever I'm speaking with to tell me briefly about their top management. Here I'm not so interested in their credentials (you can find this in the proxy statement), rather, I'm interested in any recent changes in management (and why) and the quality of the description--the feeling that management is working as a team, that this is "our" company not "my" company, that each member of the team brings a particular strength.
Recently I was at a meeting of a well-known company in which the CEO was proudly telling the audience how well top management worked as a team. However, whenever the CFO began to express his opinion, the CEO immediately cut him off and presented his own answer to an analyst's questions. It was clear that despite the positive rhetoric this company's top management did not work as a team and needed to be judged by the CEO's capabilities alone.
Overvaluation of the Company
Every executive should be optimistic about his or her company's prospects. In fact, in answer to my questions, I expect to hear a slight over-valuation of what can be accomplished in the next few years. In the same way that a psychologically healthy parent tends to slightly overvalue his or her children's strengths, management will over emphasize the company strengths, but without being grandiose about the possibilities. This overvaluation should be tempered by the capacity for a realistic assessment of what might prevent the company from achieving its goals as delineated in the annual report.
Commitment to Shareholder Value
I'm always interested in knowing how much of the company is owned by management. While this information is also in the proxy statement, I usually ask anyway because it leads easily to follow up questions such as whether there has been recent insider buying or selling and the reasons for each.
While most management won't discuss their own earnings projections, they will usually tell you if they agree with the "Street" estimate, which you should know before you call (Street estimates can be obtained from Zack's or I.B.E.S or your broker can locate the figure quickly for you). Where no Street estimates exist, as with many micro-cap companies, management should be able to tell you their expectations for top line growth in percentage terms (e.g. "I expect revenues to grow at 25% per year for the next two years."). I am less interested in the quantitative answer to the earnings question than in listening for some indication that management is truly committed to increasing shareholder value. A comment such as "we don't comment on earnings projections, but I think our shareholders will be pleased" conveys that management has the owners on one's mind. I also feel more comfortable if the CEO is familiar with the numbers rather than referring you to the CFO. In a similar vein I'm more comfortable with a CFO who has a grasp of the general business plan of the company in addition to an understanding of the numbers.
Competition
Management should be able to discuss both the specific companies with whom they compete as well as the competitive advantages of their own products or services in a manner that gives you a sense of confidence and assurance.
Encouraging Management's Thoughts
Toward the end of the conversation (try to keep it under 15 minutes), I usually suggest that I've been asking a lot of questions, and wonder if there is anything I should have asked that I didn't as a potential investor. I invite management to comment on any positives or negatives that I might not have asked about. I encourage him or her to tell me where they see the company in five years and the specifics of what could prevent the company from achieving its goals over a five year period. What I look for here is not so much the content as the general emotional tone in which the Company is discussed. "Business looks promising" can convey very different meanings depending on whether an almost giddy tone or a depressed one accompanies it.
As you talk with management, I think you'll develop your own set of questions and clues to help you read between the lines, but these suggestions should help you get started. Try to remember that most questions about the financial prospects of the company can be answered by reading the financial statements. What you are really interested in is evaluating management's ability to execute a business plan.
|
