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Management Tenets

The success or failure of a company depends on the management it has. The team managing the company has to be rational in its decision making. How does one know if the management is rational?
Deciding what to do with the company's earnings is an exercise in Logic and Rationality. If the extra cash, re-invested internally, can produce above-average returns on equity, a return that is higher than the cost of capital, then the company should retain all of its earnings and re-invest them. Buffet opines that a company that provides average or below-average investment returns but generates cash in excess of its needs has three options: -

1. Ignore the problem and continue to re-invest at below-average rates.
2. Buy growth.
3. Return the money to the shareholders.

In his view, a reasonable and responsible course for companies that have a growing pile of cash is to raise the dividend or buy back shares. People view increased dividends as a sign of companies doing well. But this is so only if investors can get more for their cash than the company could generate if it retained the earnings and re-invested in the company. When the management of a company buys the company's stock in the market, they demonstrate that they have the best interests of their owners at hand rather than the careless need to expand the corporate structure.

It is important to ensure that the management is candid with share-holders. Now, how does one know if the management is candid? Managers who report their company's financial position fully and genuinely, who admit mistakes, share successes are candid with share-holders. Managers should have the ability to communicate the performance of their company without hiding behind Generally Accepted Accounting Principles (GAAP). The data reported should answer the following key questions: -