Editor's note: It can be hard sifting through a company's dense earnings report. But according to Joel Litman – founder of our corporate affiliate Altimetry – there's one thing every investor should look for. In this piece, adapted from a February issue of Altimetry Daily Authority, he explains this key trait... and why it matters. Plus, he shares how businesses with candid management teams can tell you a lot about their overall performance.
I thought I wanted to be an engineer...
Before I ended up in accounting, I was always interested in processes and building things. But after a year of studying engineering, I realized it would be decades before I'd be allowed to design a plane's engine or anything else material.
I knew I wanted to do something where I could impact the world sooner. So I shifted gears and schools... and began my accounting journey.
I've never regretted it. However, it did mean I had to wait an extra two decades or so to meet Dave Daglio...
Dave, like me, went to school to be an engineer... only he stuck around and graduated with an engineering degree.
Eventually, he found himself working in finance, and we ended up working closely together. I believe our paths converged thanks to our shared interest in thinking about engineering and processes... and because of the importance we put on candor.
Candor goes a long way in life. And as I'll explain today, for investors, it can even help determine whether or not you make money in the markets...
Dave's mindset has led to an impressive investment career...
Dave became an Altimetry client when he was managing money for the Boston Company, aka BoCo, which was one of the most respected fund-management firms in New England.
He has won awards from AsianInvestor, Institutional Investor, Lipper, and Forbes with titles like Best Small-Cap Manager... Midcap Manager of the Year... Best Fund Over Three Years... Best Fund Over Five Years... and a place on Forbes' list of Top 20 Investors.
In fact, Dave's track record is so strong that when BoCo merged with the trillion-dollar manager BNY Mellon, management tapped him to become its chief investment officer.
How did Dave achieve this success? A core part of it was the engineer in him. He wanted to make his investing triumphs reproducible.
So, when he launched his own fund company, he named it after a well-known process in aviation: BC-GUMPS...
This is a popular mnemonic device for landing a plane safely. It gives pilots an easy way to remember to check the controls, instruments, gas, landing gear, and other items to ensure they're not forgotten.
Dave has a checklist for investing, too. He makes sure he knows the financials cold. And part of his process lines up with our work in another crucial way. It's an idea at the center of one of my favorite mantras, "incentives dictate behavior."
Once again, I'm talking about candor...
For investors, "candor" means looking for management teams who communicate to shareholders openly, honestly, and regularly.
Too often, management teams speak with fact-deficient, obfuscating generalities, aka "FOG" – a term coined by author and financial strategist L.J. Rittenhouse.
These managers hide their real thoughts – and not just because they're worried about protecting competitive advantages. FOG-filled communications often reflect managers who can't be trusted or don't know what's going on in their own business.
We want the opposite... management teams with nothing to hide and who want to work with shareholders.
When management teams are open and honest, it represents a stronger foundation for all the other decisions they make. And when they don't sugarcoat a down quarter or a down year, it ensures investors that they're focused on the long term.
Candor also leads to more than just trust. The data shows these management teams are more likely to perform well over the long term...
For years, Rittenhouse published an annual report – formally known as the Rittenhouse Rankings Candor Analytics Survey – that ranked companies based on candor. The survey used public communications (like shareholder letters and quarterly earnings calls) to see how management communicates.
In 2016, the survey reported that companies with the most candid management teams outperformed the S&P 500 over time.
So if you're going to do research to choose individual stocks, you've got to make candor a part of your research checklist.
That starts with paying attention to earnings calls. Don't just read the transcripts... Actually listen to the calls. And that goes for television interviews, quarterly webcasts, U.S. Securities and Exchange Commission filings, and other forms of communication.
You should look for management teams that take their lumps when they make mistakes... and leaders who can clearly explain what the company is doing and the metrics they judge themselves on.
On the other hand, watch out for FOG.
Good tells are when management uses a lot of jargon... when management focuses on their industry and macro factors as opposed to their own strategy and execution... or when they just say a lot of "nothing at all."
They can sound good to the untrained ear. They can also come loaded with downside risk for investors.
Prioritizing communicative management teams will help you invest in companies that are thinking about the long term. More important, it might help you avoid companies that are hiding an unforeseen risk.
So remember... if management speaks consistently and with candor, that's a sign that you're less likely to encounter risks or surprises down the road.
Editor's note: If you feel like the market has turned into a minefield, make sure you mark Wednesday, December 6 on your calendar – because Joel is coming forward to share an urgent announcement for 2024. It has to do with the recent volatility... and why a rare investment has the potential to return up to 5 times your money, even during a market crash, recession, or full-blown financial crisis. Get the details here.
"Before making an investment, make sure you know the company's key players," Joel writes. It's crucial to do your homework before putting your hard-earned money to work. You'll set yourself up for better investments if you steer clear of these corporate "red flags"... Read more here.
"Keep it simple when things aren't going your way," Chris Igou writes. You don't need to reinvent the wheel in today's market. Sometimes, sticking with what works can be your greatest ally during periods of uncertainty... Learn more here.