Value Investing Principle #3

Today I’m going to talk about Value Investing Principle #3.

Principle #3 builds on the previous two. You can review the first two principles here: Value Investing Principle #1 and Value Investing Principle #2 or you can dive into the book “Invested” or the podcast  “InvestED” both by author Danielle Town to learn more.

Value Investing Principle #3: The management of the business is honest and skilled.

I don’t get to meet the management personally and I haven’t gone to school to know what skill is needed to manage a business so how do I find out if they’re honest and skilled? This is where you’ll have to do a bit of research about their CEO and the financial situation of a business - enter the internet.

Dating a CEO

It’s been almost 2 decades since I was on a date last (gulp) but I’ve been a part of many job interviews and I see a job interview being much like a date, albeit a bit more structured and to the point, but stick with me on this one.

When you’re interested in learning more about a company to help with your decision making on whether you should invest in it, it would be really nice to have a cup or coffee or a wonderful meal with the CEO. During that date you’d be able to ask the CEO a variety of questions and they’d reveal a bit about themselves with their answers. 

From their answers you’d get to know who they are. You’d be able to learn what is important to them, their values, how they interact with other people, etc. You’d also get some great insight into how honest they are.

Unfortunately, most people won’t have this opportunity to personally go on a date with a CEO of a company they’re considering investing with. Enter the businesses Annual Reports. Each year a company releases their Annual Report which has a beautiful section towards the beginning where the CEO gets to write to the people who have invested in it’s company (aka. the shareholders, what you’re considering being).
Reading several of these letters to the Shareholders will give you a feel for the CEO. Do they openly discuss their successes and their failures? Do they sugar coat how things went during the previous year? Do they follow through with what they outlined they’d do in their previous Annual Report? 


CEOs with Great Skills 

So what kind of great skills are we talking about here? Nunchuck skills, bow hunting skills, computer hacking skills… any Napoleon Dynamite movie fans here… no, just me. I digress. I didn’t go to school to learn about what great business skills make up a wonderful CEO. I went to school to learn about being a nurse. But luckily, I can still determine if a CEO has great skills and so can you.

There are several websites which list financial information about a business. There are 5 financial numbers you will want to pay close attention to. Four numbers have to do with the growth rate of a company and one has to do with their return of money. You want a company that is growing year over year and will continue to grow for many years to come and you want their return of money to be positive (this would be equivalent to the amount of remaining cash sitting in your bank account at the end of the month which I’d imagine you’d want to be above $0). 

The 5 numbers are: Sales, Equity, Cash, Earnings Per Share and Return on Investment Capital.

Then you want to compare these 5 financial numbers about the business over the last 10 years, or more. If these 5 numbers have gone up at least 10% per year over the last 10 years, this means the CEO has great skills.

Combine the information you learnt when you Dated a CEO with the Great Skills you learnt and you will be able to make a decision about if the company can fulfil Value Investing Principle #3: The management of the business is honest and skilled.