Managers Gone Wild

1/25/2010


Any investment in a company represents at least a passive endorsement of its management.

If you buy a stock because of its growth potential, you expect management to deliver that growth. If you buy because of an impressive portfolio of new products, management must be able to both produce the gizmos and sell them effectively.

Assessing management is one of the most difficult aspects of stock analysis. The most effective strategy is simply observation, tempered with common sense.

In the following paragraphs, we’ll review three common weaknesses of management. We generally try to avoid companies that exhibit these characteristics. If you see companies you own acting in this manner, take a hard look at them.

All better now

Remember back in 2002, when General Motors predicted it would earn $10 per share by 2005? We at the Forecasts questioned that statement at the time, and GM ended up losing $18.78 per share in 2005. From 2005 through 2008, the company delivered losses of $87.2 billion from continuing operations.

The latest CEO, former AT&T ($26; T) chief Edward Whitacre, said earlier this month that GM — which emerged from bankruptcy in July — could turn a profit in 2010. Whitacre is reshuffling the executive ranks and trying to smooth the car giant’s dented image.

However, the fact that the automaker is still only predicting profitability rather than delivering it after several years of cost-cutting and the receipt of $50 billion in federal aid suggests the problem may lie in GM’s core business. Costs are high, demand is fickle, and pricing power is anemic.

The takeaway: GM will eventually go public again and issue new shares. Even if Whitacre’s bold prediction proves prescient and GM makes money in 2010, that does not mean the business is healed. It will probably take more than new management to sustain GM after it is weaned from government aid. Don’t buy into the reinvention of a longtime underperformer until you see sustained improvement.

Shopping spree

Vikram Pandit, CEO of Citigroup ($4; C), had a good reputation before his December 2007 ascension to the helm of the unwieldy behemoth with more than $2.3 trillion in assets, a product of years of acquisitions. Pandit has not yet been able to restore Citigroup to consistent profitability, and the future — for both him and his company — remains uncertain.

The difficulty in assessing management expertise in this area lies in the fact that some mergers make sense. But even acquisitions that seem wise in the abstract can cause real-life indigestion.

The takeaway: Despite the fact that many mergers don’t improve shareholder value, the bigger-is-better philosophy has long been popular on Wall Street. Whether they stem from a desire to avoid being acquired, the belief that size will improve competitive position, or simple hubris, serial acquisitions can get companies — and by extension their investors — in trouble. If your company makes a lot of acquisitions, don’t panic, but do pay close attention.

Falling behind

Motorola ($8; MOT) is a victim of its own inability to adjust to change. The wildly popular RAZR phone hit the market in November 2004, but Motorola’s follow-up products have not been well-received, criticized for their price or lack of features.

The takeaway: If your company isn’t generating fresh ideas, profit growth may become hard to find.


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