When I was younger and had far fewer freckles my mother would say, “Owen, you can love many people — but it’s much harder to find someone who you can trust.”

Rock on, Mumma Rask.

Trust is so important, especially in business and investing.

When mum gave me her advice I was probably too busy trading Pokemon cards and jumping in mud to make sense of her wisdom.

But since then mum’s advice has carried so much weight that it became one of my four key investment criteria.

And I’m not the only one who values trust…

(Please excuse me while I compare the Rask family matriarch to the great Warren Buffett and Charlie Munger — two of the world’s most successful investors.)

If you’ve been reading our free Investor Club Newsletters, you might remember my previous post detailing the Buffett-Munger investment checklist. One of their requirements is finding company managers with “integrity and talent“.

In other words, Buffett and Munger will only invest with CEOs and managers they can trust.

***

Why Trust Is So Important

As a long-term investor, you’re effectively handing your investment dollars to a professional manager or CEO.

If you’re giving them your hard-earned dough — make sure you can trust them!

You wouldn’t hand a guy on the street $2,000 without trusting them first… would you?

(if you answered ‘yes’, please let me know which way you walk to work).

When I invest in a company I’m effectively hiring a person to do something I can’t do myself, like managing the business’ assets and operations. It’s an investment in a company and a person.

As a shareholder you part-own a big business, so keep in mind that you are paying the CEO.

Now, you’re probably saying to yourself: “But I didn’t hire him and I can’t fire him. I also can’t know exactly what he does each day.”

These are all true.

We’re ‘hiring’ someone who we can’t control. And we likely don’t know all the nitty-gritties of the business.

How I Find CEOs I Can Trust – A Checklist

It might seem a big ask to invest with someone who you can trust, yet have never met.

But you can do it.

All you need is a few minutes, your Cluedo thinking cap and a bit of good old-fashioned detective work.

What I’m looking for in managers are high levels of integrity, energy (or work ethic) and intelligence. 

For the record, you can apply these techniques anywhere — not just finance. It doesn’t matter if you are searching for a financial adviser, new employees, business partners, CEOs or presenters on a stage. What you must focus on are a person’s track record and incentives.

What have they achieved in the past?

Are they likely to continue behaving in that way?

Actions speak louder than words and a track record is just that — the result of a person’s actions. Unfortunately, track records only tell you what’s already happened. Incentives tell you what they’re likely to do in the future.

It’s not perfect, I’ll admit, but I found that focusing on those two things, track records and incentives, has worked for me.

So when I’m sizing up an investment I’ll look for managers, directors and CEOs who meet the following criteria:

  • Skin in the game. This measures integrity and energy.
    There’s a saying, CEOs buy shares for one reason (i.e. they think the shares are good value) but sell for many. Ideally, you want your CEO and management to hold lots of shares in the company they run. The more of their wealth in the shares of the company the better. Why? Because their livelihood depends on it. That should compel them to work hard and do the right thing for the company.
  • Salaries are tied to long-term performance. This measures integrity, energy and intelligence.
    You can find all you need to know in a company’s annual report (or a proxy statement, if you’re in the US).
    For example, a little angel dies inside my investing heart whenever I see a 12-month sales revenue target as the requirement for a CEO to receive a massive bonus. A board of directors will set ‘hurdles’ for their CEO to reward ‘good performance’. But short-term targets can result in disaster for long-term investors like you and I. Why?
    Sales is an easy target to hit if you’re a CEO — you could simply buy another company to boost sales! They think: ‘Who cares what happens to the company and its shareholders in three or five years! I just got my sales bonus, I’m off to Europe!’
    I also choke on my cheese sandwich when I read about “golden handshakes” for directors and CEOs. These are generous incentives for CEOs who quit their job. It’s never made sense to me: Why should they receive something to quit a job? I have no idea, yet it happens a lot.
    like to see financial incentives aligned with the company’s long-term interests. (for the finance geeks like me, focus on things like diluted profit per share and return on capital)
  • Owner-run businesses are better. Energy and integrity are the focus here.
    Founder-run and family-run businesses get a big tick from me. Founders tend to have more on the line than just their financial interests — their reputation is also at stake! Their name is on the door, after all.
  • Management tenure. Energy and integrity.
    Owner-run or not, I like to see management teams who stick around for years. Apple’s CEO, Tim Cook, joined the company in 1998 — long before the iPhone, iPad and many other great gadgets were released. Years of experience also brings an intimate knowledge of a business and industry.
  • Gender equality. Integrity and intelligence.
    I don’t like when companies have a boys or girls club at the senior management level. Diversity is good for businesses in my opinion. It lowers risk by countering emotional decision making and can unearth new strategies for the company to pursue.
  • Avoid the use of debt. Integrity and intelligence.
    Debt can be useful, but it can also make mediocre companies appear better than they are… but sooner or later it can add lots of risk.
    Look at a company’s most recently issued balance sheet for “interest-bearing liabilities” or “long-term debt”. Go back a few years. Has debt grown too quick for your liking? The best businesses and CEOs grow within their means.
  • Fairness to Shareholders. Integrity and intelligence.
    If a company wants or needs more cash, they can sell new shares to investors. Issuing shares tonew investors is one thing that grinds my gears. If a company needs to raise new capital, they should offer loyal shareholders an opportunity to increase their stake in the business. CEOs and boards who offer shares to new investors check their loyalty at the door. And someone who lacks loyalty often lacks integrity.
  • Accountability. Here I’m testing integrity.
    Watch your CEO in interviews on YouTube, Sky Business, on TV, or just listen to the company’s results presentations. They make promises, so check whether they’ve achieved what they said they would. Has their attitude changed? Are they able to explain their products and strategy in a clear and succinct way? If you can’t make sense of what they’re saying, chances are, it doesn’t make sense to them either. Write management’s key statements down on a piece of paper and come back to them the next time they present. Remember what they don’t answer — sometimes this is more important than what they do answer!.
  • Experience & education. Intelligence.
    Does management have the skills and/or the relevant experience to run the business? Horses for courses. For example, I would expect at least one doctor to be on the board of a biotechnology business but none on the board of a pizza chain. This information should be listed in the Annual Report or Proxy Statement (US).

Takeaway

As I wrote here, repeated studies have found that people spend more time researching TVs, restaurants and holidays than organising their finances.

I think you will agree that it is vitally important to not only consider how you can maximise your finances but also who you choose to do business with.

If you find the right person in the right business the other stuff works itself out. So if you’re investing in a CEO or employee for your business, set aside some time to consider the incentives and track records of the people you wish to work and invest your time and money alongside.

Bringing It All Together

It’s important to be thorough when you assess management because identifying great people may help you find great investments.

If you’ve been reading our Free Investor Club Emails, you could use this discussion of management and people with my recent material on Moats, staying within your circle of competence, and Valuation.

Let me know what you think. Has understanding incentives and personal qualities made you a better investor of your time and money?

I would love to hear from you.

Cheers to our financial futures!
Owen Raszkiewicz

Founder and Lead Advisor,
Rask Invest

Download my free investing in Australia ebook when you join our free Investor Club newsletter. The ebook is jam-packed with tips for investing in Australia businesses. Best of all it’s free — and includes a few quotes from Warren Buffett!

Click here for the free report called, “What Warren Buffett’s Investment Checklist Can Teach Aussie Investors”

 

This article contains general financial information only and should not be relied upon. This information does not take into consideration your needs, goals or objectives. Therefore, you should consult a licensed financial adviser before acting on any of the information presented here. Past performance is no guarantee of future returns. At the time of publishing this article, Owen Raszkiewicz does not have a financial interest in the companies mentioned. 

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