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Warren Buffett’s Search for the Next Walmart

By JLP | September 29, 2010

I just read an interesting Motley Fool interview with Prem Jain, author of Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing*, a book that has been in my to-be-read stack for a couple of months. Professor Jain was asked for pointers that investors can use in assessing company management. His response:

1. Is the management competent?

2. Are management incentives aligned with the shareholders?

For the first point, Professor Jain said that he looked at “…earnings, the return on equity, and the allocation of cash flows for more than 25 years.” He also mentioned that a “…a carefully computed return-on-equity ratio is probably the most important metric for determining management competence.” Nothing really surprising here.

On the second point, I thought this was interesting:

“I check the number of shares held by the CEO and other top managers in the company. I am suspicious of CEOs who are awarded a large number of stock options but hold only a small number of shares.” Professor Jain also likes to see management promoted from within the company and management types that live a frugal lifestyle.

I, too, like to see management with large stakes in the company’s stock (preferrably not options that can be manipulated with short-term earnings) rather than large paychecks. I also don’t like huge severance packages because they present a moral hazard. CEOs that drive a company into the ground should not be fired and walk away with a huge severance package.

I guess I’m going to have to get Professor Jain’s book off my shelf and give it a read.

*Affiliate Link

Topics: Investing | 5 Comments »


5 Responses to “Warren Buffett’s Search for the Next Walmart”

  1. Kirk Kinder Says:
    September 29th, 2010 at 8:22 am

    Assessing management is harder than most think. Certainly, the metrics mentioned here are fine, but Warren Buffett gets to personally know the management and ask questions. We don’t. This makes the evaluation of management a difficult task. Just look at the Good to Great books. They identified “great” companies and pointed to the management as the key. Of course, many of the companies profiled by these groups (Fannie, Citi) have turned out to be total duds…with the same “great’ management in place.

    This is why it is very difficult to assess individual stocks. It isn’t to say it cannot be done, but it is much harder than most think.

  2. Vishal Says:
    September 29th, 2010 at 8:35 am

    Thanks JLP. I added this book to my list of ‘must read books for 2010′ as well…..we’ll see how it goes…

  3. Harm Says:
    September 29th, 2010 at 11:15 pm

    The spelling is “hazard”….just sayin’…..
    Your blog is great, JLP, I just can’t resist
    correcting sometimes, LoL.

  4. JLP Says:
    September 29th, 2010 at 11:41 pm

    Thanks, Harm. I didn’t catch that mistake. I hate typos. That’s one of the things that bugs me about facebook is that I can’t correct typos without deleting the entire post. What makes it really bad is I have friends who like to harrass me on facebook…lol.

  5. BuffettFan Says:
    October 15th, 2010 at 9:40 am

    I saw this article saying Warren Buffett has not generated any alpha in 10 years:

    Warren Buffett’s Alpha and Returns

    Does this make sense to you?

Comments