One of the most fundamental factors that is consistent across the majority of company success stories in the NAOS investment universe is, arguably, a high-quality leader. Simply put, no matter how good a company may appear on paper, if we are not comfortable with the CEO, we will not invest. On the flip side, we may be able to look past a business with certain issues if we have a lot of confidence in the leader.
Here are five key points to consider when assessing the value and quality of the person at the top.
The message portrayed to the market on the company’s strategy needs to remain consistent over the short, medium and long term. Investors will build their investment thesis around this message. If the CEO’s message changes either positively or negatively, it is time to review your investment. If it changes frequently, it is time to reconsider your investment altogether. We like to look back to our previous notes to see if they have done what they said they would do – there is great benefit for all investors who practise this.
A management bio will give you the information you require to go back and learn from the past. Anyone who has had multiple, short tenures in different businesses would raise a red flag. Ideally, we like to see a CEO who has demonstrated building long-term shareholder value in a similar sector/industry throughout their career. Channel checking is always recommended, whether it be to fact check an industry, sector, company or manager.
3. Shares and incentives
It is no secret that investors like to see a capable management team with skin in the game – this is a very powerful factor when selecting an investment. Furthermore, it can be a warning sign if the leader of a small/micro-cap stock doesn’t hold a substantial position. Alignment extends to the incentive structures in place for the leadership team and we recommend having a good understanding of all key contributors.
Be cautious if share price is the only focus, as this may cause a CEO to concentrate on short-term decisions that create ‘hot air’ in a stock and could be detrimental to the business in the longer term. We prefer to see earnings per share growth included as a reward metric, as this reflects a focus on improving business quality over the long term. If this is delivered upon, it should reflect positively on the share price.
4. Commerciality vs lab coat
By their very nature, small businesses are hands on and those in charge can benefit from being ‘Jack of all trades’ type leaders. A high-quality CEO will have the ability to candidly and confidently talk about all parts of their business in a way that investors understand. We get a lot of comfort from a leader who is able to answer questions about the smallest of issues, or show an understanding of their customer base by explaining a key client in detail - this is the ‘lab coat’ part of a management skillset.
At the same time, they must be commercial. Here, we would look for managers who have a good handle on their competitors, corporate activity and their own share register. This might sound like a lot to ask, but quality CEO’s do this naturally in equal balance.
5. What makes them tick?
Trying to understand the motivation of a CEO can be very subjective. In simple terms, we like to see something more than just the financial aspect which drives someone to run a business every day. Generally, a small company is started because a CEO wants to take a chance and provide something different from the industry status quo. It is a case by case assessment of the individual and the company they are leading, however passion, confidence and commitment are crucial to create long-term
Written by Robert Miller, Portfolio Manager, contributed by NAOS Asset Management
The two listed investment companies (‘LIC’s’) that Naos Asset Management manage, are the Naos Emerging Opportunities Company (ASX: NCC) and the Naos Absolute Opportunities Company Limited (ASX: NAC).
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
NAOS believe ‘it is impossible to produce a superior return unless you do something different to the majority’, we find quality companies at attractive values and apply a patient, high conviction and often a contrarian investment approach to...
Would be great if you listed some of the companies that have CEOs who pass your filters. Maybe an idea for a follow up article
Thanks James, great idea.