Going beyond the numbers

Analysis of financial statistics must be supplemented with an appraisal, mostly of a qualitative nature, of the company’s present situation and prospects and the quality of its management.

Sizing up the present situation and Prospects:

To size up the company’s present situation and prospects, you may ask questions along the following lines:

Availability and cost of Inputs: Is the company well placed with respect to the availability of basic raw materials, power, fuel, and other production inputs? What are the cost advantages / disadvantages of the company vis-à-vis its competitors?

Order Position: What is the order position of the company? How many months or years of production does it represent? Is the order position improving or deteriorating?

Regulatory Framework: What is the licensing policy applicable to the industry to which the firm belongs? Are there any price and/or distribution controls applicable to the company? If so, what are their implications for profitability?

Technological and Production Capabilities: What is the technological competence of the firm? What is the state of its plant and machinery? Does the company have unutilized capacity to exploit favorable market development?

Marketing and Distribution: What is the image of the company in the marketplace? How strong is the loyalty of its customers / clients? What is the reach of the distribution network?

Finance and Accounting: What are the internal accruals? How much access does the company have to external financing? How conservative or liberal are the accounting policies of the firm? Does the company take great efforts to manage the bottom line? Is the deprecation charge adequate? What are the products in the portfolio of the company? What are the prospects of these products? How competitive is the position of the company in these products? What are the overall prospects of the company?

Human Resources and Personnel: How competent and skilled is the workforce of the company? Is the company over-staffed or under-staffed? What is the extent of employee turnover and absenteeism? How high is employee productivity? What is the state of industrial relations? What is the level of employee motivation and morale?

Some information relating to the above questions may be available in the annual report of the company, some can be gathered from the financial press, and the rest may be obtained from the officials of the company.

Evaluation of Management: Many financial analysts believe that there is no need to consider management as an independent factor in company analysis because the quality of management is reflected in sales growth, profit margins, return on equity and so forth. Management experts, however, argue that management and ‘the numbers’ should be regarded as separate aspects. Peter F Drucker for example observed that: The performance of a business today is largely a result of the performance or lack of it, of earlier managements of years past. Good management means doing a good job in preparing today’s business for the future. Echoing a similar thought, Theodore Levitt wrote that ‘the mark of good management is not simply how it runs its businesses but how well it changes them. We subscribe to the view that the quality of management is an important factor shaping the success of the firm and returns to shareholders and hence calls for a separate evaluation.

While a firm may earn superior returns on account of competitive advantage arising from factors like proprietary technology, strategic location access to cheap raw materials, scale of operations, and brand equity, the quality of management is perhaps the key factor shaping the profitability of a firm. The sterling performance of firms like Infosys, Reliance, WIPRO, HDFC, Asian Paints and Bharati Tele-services can be attributed mainly to their outstanding management.

To assess the quality of management, the analysts should ask questions like.

1. What is the grand design of management? Does it believe in ‘staying close to the knitting’ or unrelated diversification?
2. What is the caliber, motivation integrity, dynamism and commitment of the top management personnel?
3. Does the management have specific objectives, plans, and time bound programs?
4. What emphasis is accorded to research and development?
5. How effective is the organizational structure?
6. How sound are the management systems of the company?
7. What is the importance assigned to management development?
8. How investor-friendly is the management?
9. How strong is the execution capability of the management?