Philip Fisher On Management Integrity

In the investment classic, Common Stocks and Uncommon Profits , the late Philip Fisher wrote about 15 points one should consider when buying a stock (chapter 3).

The last 2 points (points 14 & points 15) focused on the issue of management integrity.

• Does the management talk freely to investors about its affairs when things are going well but “clam up” when troubles and disappointments occur?
• Does the company have a management of unquestionable integrity?

According to Fisher in point number 14:

• The management that does not report as freely when things are going badly as when they are going well usually 'clams up' in this way for one of several rather significant reasons. It may not have a program worked out to solve the unanticipated difficulty. It may have become panicky. It may not have an adequate sense of responsibility to its shareholders, seeing no reason why it should report more than what may seem expedient at the moment. In any event, the investor would do well to exclude from investment in any company that withholds or tries to hide bad news.

There was one nice example back in 2006 which reflects what Mr. Fisher is talking about. See DVM: Part III.

The company makes a rather huge loss. And instead of even explaining to the investing public why and how the losses occured, the executive director of the company talked about being optimistic about the company's future prospects!!!!

According to Fisher, "It is the nature of business that in even the best run companies unexpected difficulties, profit squeezes, and unfavorable shift in demand for their products will at times occur."

For example, a well-managed company under-taking a massive plant expansion might face unexpected delays, unexpected expenses or unbudgeted costs. And this delay totally messes up the management's profit forecasts or could it even put a huge damper on the group's profits. (Remember Mieco case?)

And according to Fisher, "How a management reacts to such matters can be a valuable clue the investor."

Now in the plant expansion example, some management may 'calm up' their investors by not telling the investors what exactly is happening because the mangement does not want to create an impression that either things are out of control or they do not have a contingency plan to correct what is going wrong.

And according to Fisher, "The investor will do well to exclude from investment any company that withholds or tries to hide bad news."

How about the case of Tong Herr?

The company reports in its latest quarterly earnings that:

• The higher revenue and lower profit before income tax for this quarter are due to higher demand for the product and higher cost of raw materials purchased in the preceding quarters.

However, in a press interview, Tong Herr to invest RM70m on production, the boss said the following.

• Tsai said Tong Herr will also invest RM25 million to expand its 7,000 sq ft Thai factory located at the Amata Nakorn Industrial Estate in Chonburi, adding that rising steel prices had very little impact on Tong Herr's bottom lines.

Contrary statements made! How would you rate such management?

Or how about the example mentioned in Review Of Hai-O?

The company declares the following to the mass media. (see http://www.hai-o.com.my/cms/layout/Printer.asp?ProductID=62 )

• On why Hai-O was venturing into the IT sector, he said: “We are debt free and cash rich as we have RM8mil in fixed deposits, RM4mil in our current account, and RM20mil in overdraft facilities. Therefore, we will venture into any business if it can bring us some benefit.”

However, if one digs deeper, one would have noted that HaiO had a Rights Issue in 2003. Now wouldn't this give a brand new meaning of being cash rich company, yes? Well, their debt free and cash rich was not via the company's hard work but the net cash resulted from a rights issue!

And how would you rate such management?

Movinng on, regarding the issue of integrity, I do find this is a simple no-brainer.

Does it make sense to go into a business-partnership with someone you do not trust?

Why should it be different in the stock market?

It is hard to imagine why anyone would want to go into a business partnership with someone who would most likely cheat us the minute we turn our back.

According to Fisher, the management of a company is always for closer to its assets than its shareholders. And without even breaking any laws, there are number of ways that the management can benefit themselves and their families at the expense of the minority shareholders, for example employing their relatives, buy-and-selling of properties between relatives at above market rates or the issuing common stock options.

It's not only the dislike for dealing with unscrupulous people but Fisher believes that companies managed by people of dubious integrity will definitely meet with failure. (Don't you agree?) For those in control would attempt to make money at the expense of the minority shareholders for these minority means nothing to them but mere other people's money who are there for them to abuse!