Earlier this week, I mentioned in my article “Opportunity Cost: Buffett & Munger’s Powerful Investing Filter” that Buffett looks for companies with capable and honest management. In response, a reader at Gurufocus.com where the article was also published asked if I had, “Any additional insight into the exact qualifications and evaluation criteria that he may use to evaluate this.” This is a very important question so I am posting my answer on the blog.
1. Do they have a meaningful part of their net worth invested in the company?
2. Is their compensation reasonable?
3. Do they try to manage earnings (a negative) or do they manage the business for the long-term as evidenced by being honest about short-term volatility and challenges they are facing?
4. Is the discussion of the business in the annual report forthright and honest or it is promotional and filled with marketing speak? Does it appear to be written by the CEO or the head of investor relations?
5. What is their record on capital allocation? Go over their track record for the past ten years. Do they repurchase shares when the company is clearly undervalued? Have they made dumb acquisitions by overpaying for businesses with mediocre prospects or devoid of competitive advantages?
6. Have they stayed focused on what they set-out to accomplish? Is it impressive? Buffett has grown book value 434,000% over the past 45 years vs. 5,430% for the market (no typo). Prem Watsa has grown per share book value at a rate of 25.7% for 24 years. Sometimes it just jumps off the page. Look for the .400 hitters and hitch a ride.