“So you are sure you will be able to meet your sales growth target for this year?” I asked as the CEO of the company looked at me.
“Yeah, we are pretty sure that we’ll be able to grow our sales by 30% this year and the next one, and 25% every year thereon.”
“And what are the risks you face?”
“Risks? Hmmm.” He looked out of the window for a minute, then turned back to me, and said, “I don’t foresee any risk for our company, at least not over the next one year.”
This was how my meetings with the CEOs or CFOs of companies went through when I had just started in my career as a stock market analyst.
Whatever the CEOs and CFOs told me were like words cast in stone.
So if they were confident of a 30% growth in their company’s sales for the next 10 years, even I was confident that they’d we able to achieve that…and without any risks!
And if they were confident they won’t be making any poor investment decisions in the future, even I was confident that they’ll stick to whatever they were saying.
Well, it took me almost 4 years and a few bad recommendations to realize that whatever company managements say must NOT be taken at face value.
It’s psychologically dangerous, because analysts and investors who talk to management get confident for all the wrong reasons.
This is not because CEOs and CFOs are liars. This is because we are all liars…and especially to ourselves.
We generally look at our plans and decisions wearing rose-tinted glasses.
So, if you question the CEO, “Are you going to do a stupid acquisition?” there’s a great chance he’ll tell you what you want to hear (“No!”) until one minute before he announces he has done the exact opposite thing (i.e., actually did a stupid acquisition).
But then, people never change. That sounds harsh. But it’s an effective way to invest.
A management that has a history of borrowing money to grow its business will keep borrowing. A CEO who is a serial acquirer will keep acquiring companies left, right, and centre. Someone who has a history of going overboard with future plans will continue to go overboard with future plans.
Now, whenever I am studying a company’s managers, I start with the mindset of seeing them ‘guilty until proven innocent’.
So if they have a history of making bad decisions, I don’t believe them when they say they’ll stop making such decisions in the future.
I treat it just like if an alcoholic said, “Tomorrow I’m going to stop drinking.”
Okay. I appreciate the sentiment. But we both know what’s going to happen tomorrow!
The Lesson Learnt
Business channels have this habit of calling top managers on their shows just after their companies have announced quarterly results.
More often than not, even when a company is staring at a deep slowdown in sales and profits in the future, the manager will be at his buoyant best.
“This slowdown is just a short term thing. We are confident of a strong growth in the future,” he would assure viewers.
Now whether viewers get assured or not is a different story. The anchor definitely is impressed and his follow up questions to this manager are just to support the latter’s claim that ‘the future is bright’.
I used to think the kind of questions that were asked to the managements on these channels were quite impressive.
That is till the time I also laid immense confidence on whatever the managements promised me during our research meetings.
But, after I learnt the lesson of not taking the management’s words on face value, and instead doing an independent and unbiased analysis on companies, those questions seemed hilarious.
Anyways, that’s not the real point here.
The real point is that until you as an investor get demonstrated proof of the management’s change in behaviour (from bad to good) – not just language but a real change – just smile and nod and not believe a word they say.
Some would advise that you can avoid studying a company’s management before buying a stock because there are no numbers to measure a management’s performance.
But that is a very bad idea.
You must assess or talk to a company’s management to understand its past behaviour – capital allocation record, business ethics, and shareholder friendliness…and to assess whether they are the right people to guide the business in the future.
But asking managers how fast the company will grow in the future and how confident they are on its plans? That’s not worth your time and effort.
I admit it. It’s taken me years to get this simple lesson through my thick skull.
I hope you can learn this lesson quicker than I did.