Qualitative Investment Checklist – The Touchy Feely Stuff

Qualitative Investment Checklist – The Touchy Feely Stuff

The thought came to me the other day whilst discussing stocks with some investing friends that an investment ‘checklist’ is a really useful tool to avoid some of the potential investing pitfalls, especially in the small cap market.

We probably all have some form of checklist whether in written form or perhaps more etched into our brains when surveying a potential new investment, so I thought I’d have a go at trying to capture some of the things I look for in an investment and share them for discussion and critique.

What I quickly realised when thinking about my ‘list’ was that my qualitative bias was going to dominate and that perhaps this is no bad thing as I think qualitative research techniques get much less air time than more well-trodden quantitative research techniques such as checklists used for screening e.g. PE<20, ROCE >20% etc.

I hope the following is food for thought.

Management

For me personally, this is it.

The Board of Directors are, after all, the ones stewarding our hard-earned cash. So, what should investors look for in a good management team?

Diversity

  1. Is the Board male dominated? Hopefully not but probably very likely, although this is slowly changing.
  2. Is it all a bit cosy with the CEO’s old university buddies as NEDs? I like NEDs who bring different thinking to the Board and give some level of independence. Hard to measure sometimes, or at least initially, but over time I find it becomes more apparent. Have the NEDs been in the post too long?
  3. Is there a succession plan – are younger senior managers in-line and empowered?
  4. Too many Executive Directors? Depends possibly on the size/nature of the business but does a company really need 8 Board Directors?
  5. Is the Board compliant with the new (Sep 2018) LSE listing rules (AIM Notice 50) especially with respect to number of non-execs?
Aligned with Shareholders

Determining the quality of management for me means looking for alignment with shareholders (retail as well as institutional):

  1. Do the Board have good Bio’s / CV’s and a strong reputation? Check them out on Facebook, Companies House, Google, LinkedIn. Speak to their customers, their staff, their competitors. What car do they drive? A Bentley is not a good sign; a 6-year-old BMW gets a thumbs up.
  2. Do they seem honest and trustworthy and can you relate to them? I have seen numerous CEOs present over the years and sometimes whilst their presentation may seem very slick, I can’t perceive being able to build a CEO / shareholder relationship with them. I am looking for an edge and part of that edge is forming a long-standing (arms reach) relationship with them.
  3. Is the head office / reception way too swanky? There is a balance between having a dour front-of-house (demotivating for employees and uninspiring for Clients) and having a £50k sculpture in reception along with too much glass, granite and bling. Keep the cash in the till please.
  4. Does the IR section of their website make it easy for investors to contact the company in the first place i.e. email address etc. and also is it comprehensive and up-to-date? This varies hugely.
  5. Does the company respond to your email(s) or phone calls in a timely and comprehensive manner (perhaps you have to chase them up once) – if they don’t respond after chasing, the red flag is starting to go up.
  6. They don’t spend all day on Twitter. I won’t mention the CEO I am thinking of.
  7. The AGM is at a reasonable time in the morning (i.e. not at 9am), investors are warmly welcomed and the Board offer a Q&A session after the formal business of the AGM.
  8. Do the Board complement each other (your hair looks nice today) – no! How do they come across at the AGM – does the Chairman / CEO hog the limelight or does he/she let the FD or one of the other Board members speak? Are Ego’s in check?
  9. Does the company do what it says it’s going to do, whether actions stated in the Annual Report or things discussed over email or at the AGM?
Remuneration

  1. How many pages of the Annual Report are given to the Remuneration Committee? Some companies find the need for >15 pages; others less then 6 pages. Less is more in my opinion.  It can be a telling sign of Management motivation.
  2. Are the Board paying themselves too much? ShareSoc has done some excellent work on this topic. Personally, in my small cap universe (for me, that is typically companies with a sub £400 million market cap and often sub £50 million) I like to see a CEO salary of no more than £250k with the FD/CFO likely getting proportionally less. Bonuses, pension contributions and other payments (such as options) often bump Board pay up a lot more anyway. In the case of one of my holdings the CEO earned nearly £900k in 2017 including bonuses; a significant sum and it was duly questioned at the AGM.
  3. Options. I am pro-incentives but generally I only like options when they are linked to clear tangible (and stretching) performance targets i.e. growth in ROCE, PTP / EPS and without scope for accounting gimmickry.
Stock Ownership    

Source: Inland Homes plc 2016 Annual Report 2016.

  1. Are the Board aligned with shareholders by owning a noteworthy holding of stock themselves? If not, why not? If they don’t, find out if future purchases are likely – you might get some interesting answers!
  2. Directors buying / selling. This is a topic of much debate. Clearly, it’s good to see Directors buying shares but sometimes there will be orchestrated buying of small quantities of stock (probably as suggested by their Broker / NOMAD) – this isn’t so good. Some Directors also have no idea what their Company is worth and I have had conversations with Directors who also have surprising little knowledge about investing – you will be amazed, and not always in a good way. The Board are regular people just like you and I and sometimes they want to sell some of their stock (new house, divorce, 2nd house….!) and I take each sale of stock by a Director on a case-by-case basis; it’s not always a negative sign.
  3. NEDs owning stock. One train of thought is that non-execs shouldn’t own any stock as this could impair their independence. Personally, I am happy to see non-execs buying stock.

Other than all things Management, I have some other key considerations that I like to check / research:

Company Location

  1. This may seem irrelevant, but I do give consideration to where the business is located simply because I want to be able to attend the AGM without having to travel the whole day or stay overnight. With investor events such as Mello and those offered by ShareSoc, etc which provide increasing access to management, this is becoming less of a consideration.
  2. Typically I avoid overseas listed stocks, not only because of lack of access to management but the statistical probability that they might be dodgy!
Advisors
  1. Does the company have reputable advisors?  With the list of AIM frauds increasing year-on-year it doesn’t take much to put two and two together and work out that some advisors are better than others, whether the NOMAD, Auditor, Broker or all three.  Just two of many useful reference points in the public  domain are here and here to highlight the issue.
  2. Does a £20 million market cap AIM listed company really need joint (2) brokers? More cost.
  3. Changes in brokers – sometimes this can be a sign of an upcoming fundraise.
Shareholder Register

Source: D4T4 Solutions plc 2018 Annual Report.

  1. Is the shareholder register suitably diversified with reputable small cap funds owning stock?
  2. Do Directors feature on the list (see ‘stock ownership’ above)
  3. Who are some of the names on the register – a quick Google search may reveal they are another retail investor like you – make contact?
  4. What % of stock is available (free float)
Bulletin Boards / Social Media

Oh, where to start!  Despite some people throwing up their arms in despair at the content on some of the well-known investment bulletin boards, I find them very useful although typically I only use the ADVFN one after the demise of the much loved Motley Fool boards. An increasingly useful investing ‘resource’ for me nowadays is Twitter where investors will find many kindred retail investor spirits to share information with (or mock!) as well as gaining a degree of access to some company directors, competitors, industry information and everything in between.  Embrace the blue bird.

Summary

In conclusion, other than traditional screening for stocks based on financial metrics, I strongly believe that time is well spent by investors doing some leg-work on the more touchy feely stuff, some of which I have covered above. This is all part of scuttlebutt as popularised by Phil Fisher.  For me, its a gold mine.

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    Worth developing this useful checklist further on factors such as industry and sector, strategy and positioning and competition. 

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