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Steady hand on the tiller or captain of a rudderless ship?

Glenn Freeman  |  20 Jan 2017Text size  Decrease  Increase  |  

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The quality of a company's leadership team is a key determinant of its success, and analysis of senior executives should form an important part of your investment decision-making process.

 

Undertaking in-depth research and due diligence is vital to successful investing, but there are always unknowns that create risk for investors.

"One way to help reduce this risk is to analyse the management and leadership of companies before investing in them," says Chris Bedingfield, principal and joint managing director, Quay Global Investors--a fund manager owned by Bennelong Capital.

Such considerations are an important component of Morningstar's equity research methodology, with each company under coverage awarded a stewardship rating of Exemplary, Standard or Poor.

This has been part of the equity analyst toolkit at Morningstar Australia since 2014, having been first rolled out in the US in 2012.

The stewardship rating looks at whether management's capital-allocation decisions have enhanced or eroded a company's competitive position and shareholder value over time. It is closely linked with the moat rating, which measures a company's competitive advantage, and which in turn should translate into excess returns.

The longer these excess returns are expected to endure, the wider or stronger the economic moat. Exemplary stewards of shareholder capital will invest in moat-widening projects.

Adam Fleck, regional director of research, Morningstar Australasia, says the emphasis is on how individual companies are "stewards of capital, not of governance and board structure".

He says how a company's board is organised is often not material to its performance. "But if its chairman and CEO together are doing a terrible job of managing the company, then of course, we'll take that into account," Fleck says.

Australia's corporate sector is littered with examples of the correlation between senior executive performance and company value, and even collapse.

Steelmaker Arrium is one prominent example. Before its collapse, the board of the now-liquidated company was broadly criticised by corporate investors, shareholders and other stakeholders for numerous examples of poor financial stewardship, compounded by off-kilter senior executive remuneration.

In years gone by, companies like HIH and OneTel, once market darlings, collapsed under the weight of mismanagement.

However, as Morningstar's research shows, a reduced stewardship rating doesn't necessarily spell disaster.

Just this week, the stewardship rating of healthcare company Sirtex (ASX: SRX) was reduced to Standard from Exemplary, after the termination of long-standing CEO Gilman Wong. The board dismissed Wong after an investigation into his trading of Sirtex shares.

While Sirtex's stewardship rating was reduced, Morningstar equity analyst Chris Kallos notes the company remains in a strong financial position, with cash and cash equivalents of $107 million, and no debt.

"We maintain our $28 per share fair value estimate for Sirtex and view the shares as undervalued at current levels, given the over-40 per cent discount to our intrinsic assessment," Kallos says.

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Glenn Freeman is Morningstar's senior editor.

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