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It is, of course, important to ensure, as far as you are able, that the management of any company in which you invest is both competent and honest. The difficulty arises in judging people from a brief meeting or form reading annual reports, brokers’ circulars, magazines and newspapers.

Anybody can see from the wonderful growth record of an established company like Rentokil that its chief executive, Clive Thompson, knows a thing or two about management and is able to inspire his team. Equally, even with a less well-known company like Admiral, it is undoubtedly apparent from the company’s ten-year record of unbroken EPS growth that Clay Brendish is doing a first-class job. It is much harder to make a sensible judgement with companies in their very early stages, when the record is insufficient to form a reliable guide to the management’s capabilities.

It is important to remember that if the management of a company is intent upon fooling you, all of the cards are stacked in its favour. You might, for example, visit the chief executive of an engineering business with the idea of being shown the factory and then joining a select group of his colleagues afterwards for lunch. You would undoubtedly be impressed if, during your trip around the factory, the chief executive explained in detail the inner workings of a new state-of-the-art machine that was about to transform the profitability of the company’s core business. You would also be impressed if he put his arm around the shoulders of one of the operatives and said, ‘Fred’s been with us eighteen years now – how’s the new baby, Fred?’ from these two incidents you would probably gain the impression that the chief executive had a good personal relationship with the work force and, into the bargain, was technically gifted.

It is, or course, possible that you would be right. However, there is also a chance that the chief executive had studied the technical details of just one or two machines and that his relationship with Fred was part of his act when showing visitors around the factory. It is even possible that Fred’s name was really Charlie, but he was too frightened to say so.

In the same vein, you can imagine how, over lunch with the other executives, the conversation could be kept away from problems with a new product or the impending strike at one of their factories. Instead, it could easily be steered towards a pleasing increase in like-for-like sales and the overhead savings and other benefits arising from a recent acquisition.

The point to bear in mind is that you would be meeting the chief executive in an environment which he knows and controls, so you would be seeing him at his very best. It is a very different matter if a relationship is developed with a management that has been tried and tested over a long period. On many occasions, I have met chief executives who impressed me and my investments in their companies turned out to be exceptionally profitable. Over a period of a few years, I have got to know the managements in question and my confidence in them gradually increased as they continued to deliver on their promises to shareholders. I regret to say there is an equally long list of managers who have been very disappointing.

Perhaps the most useful aspect of a visit to a company is the opportunity to observe the general behaviour and attitude of the executives and staff. Is the telephone answered quickly, pleasantly and efficiently? Is the receptionist alert and on-the-ball? Do the staff deal with enquiries promptly and seem to have a sense of purpose? Are the personnel you speak to enthusiastic about the company and obviously proud of it? Are they the kind of people you would like to employ? In a word, is there a corporate spirit that will make your investment a winner?

It is a good idea to attend AGMs to see whether or not they are well organised and how well the chairman and the chief executive field questions. Bear in mind though that, even at AGMs, management often arranges for a few prepared questions to be raised.

Overly lavish annual reports littered with colour photographs, especially of the chairman and other directors, are usually a worrying sign. The best-known example was Spring Ram, which took the opportunity each year to stress an annual theme such as ‘Winning Through Teamwork’. After a major setback it was not long before the founder, Bill Rooney, was removed from that team in response to institutional pressure.

The auditor’s report should, of course, be checked to ensure that there is no qualification of any kind. You should also always read the detailed notes to the report and accounts, as sometimes very significant points are tucked away in the small print.

Many years ago, there were a few amusing articles in one of the Sunday papers suggesting a points system for assessing the quality of the board of directors. I cannot remember exactly how plus points were gained, but I do remember that deductions were made for politicians, admirals and the like. I suppose the underlying thought was that politicians and admirals might be on the board simply for the sake of appearances, as opposed to any contribution they were likely to make to a company’s progress.

Beware of chief executives who are always sounding off about their industry and always seem to be giving interviews about the state of the country and industry in general. They might be thinking too much about the possibility of being knighted and too little about the company that employs them.

It can be a bad sign if the chief executive acquires a substantial financial interest in a football club or becomes chairman of one.

Any chief executive who fails to meet a formal profit forecast is on a slippery slope. Institutional backing will be much harder to obtain next time around, so further fund-raising capacity might be put in jeopardy. Even failing by a wide margin to live up to the brokers’ consensus forecast can be a serious problem. If the analytical skills of a large number of highly paid brokers are put in doubt, they will want to blame someone.

As the future progress of many growing companies depends to a large extent upon share placings, the calibre of the company’s stockbrokers, merchant bankers and investing institutions is material consideration. A first-class incoming executive team will invariably attract top-level support.

With all my investments, I concentrate mainly on the financial statistics. However, I keep an eye on pointers like these to give me the feel of a company and of the chief executive running it. In my sometimes bitter experience, these kinds of measures can often give you a better general impression than you would obtain by making a company visit or meeting the chief executive for lunch.

The appointment of a new chief executive can herald the complete transformation of a company. This is especially the case if the incoming CEO is someone of high repute with a good track record and the company he is joining is known to be poorly managed.

The appointment of Archie Norman as CEO of Asda and Gerry Robinson as CEO of Granada were obvious examples. The two charts below begin when the appointments were made and show that they were followed by very substantial advances in the companies’ share prices.

It is often difficult to determine if a new CEO is really capable. It is always worth trying to check the EPS growth record of the CEO’s previous company, but often insufficient information is available, so investors have to rely upon newspaper comment and profiles in magazines.

REFS gives details of changes of CEOs during the previous twelve months, together with the actual words used in the press releases. Formal announcements of the retirement of CEOs have to be read with a pinch of salt. Sometimes they are completely genuine, but on other occasions ‘Retirement due to ill-health’ can mean ‘Judged incompetent by common acclaim’ and ‘Wishes to reduce his executive responsibilities’ is a polite way of saying ‘He has done enough damage to the company already.’

It should be borne in mind that the other side of the coin to a very capable new CEO being appointed is that he or she can be tempted away by a better offer. It is therefore unwise to place too much reliance on the new CEO and to concentrate on ensuring that the underlying business is sound. Managers are mobile and frequently hop from one company to another, as George Simpson’s move from Lucas to GEC demonstrates only too well.

A superb new CEO is a major reason for investing in a company, but it should not be the only reason. Warren Buffett’s wry observation bears this out: ‘When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.’

Before finally selecting a share to buy or sell, investors should, as a matter of routine, always make themselves aware of recent share dealings by directors. It is pertinent to note that in an August 1993 study, Smith New Court (now part of Merrill Lynch) demonstrated that simply by following directors’ dealings an investor could have outperformed the stock market.

The most important thing to bear in mind is that directors’ buying is far more important than directors’ selling. A director investing a significant amount of cash in his or her company presumably feels that the shares are undervalued and are a better investment than cash. The same argument does not necessarily apply in reverse. The director may have decided that the shares are overvalued, but equally the money could be needed for another perfectly valid purpose – to buy a new house, meet a call from Lloyds or simply fund an expensive lifestyle.

Another important point is the number of directors buying or selling. If a cluster of them buys shares, this substantially strengthens the buying signal. The selling signal is also much clearer if a number of directors are unloading shares.

The significance of the share deals in relation to the number of shares a director holds is also highly relevant. So is the position of the director who is dealing. A purchase of 10,000 shares by a chairman who already owns over one million shares is of no particular importance – he might just be showing the flag at a time of difficulty. But a finance director doubling his holding from 10,000 to 20,000 is a strong message. Similarly, a sales director selling 10,000 shares out of a holding of only 12,000 would put me on red alert.

The above schedule of directors’ dealings is taken from the table volume of the April 1996 issue of REFS. As you can see it is a classic example of a cluster of directors buying a significant number of shares in relation to their existing holdings. I was attracted to the shares by the first tranche of buying at 64p in January 1996 and bought some after the February tranche at 69p. In late May, the company’s annual results showed a massive increase in profits and the company’s broker forecast further very substantial progress in the current year. The day after the announcement the shares rose to 160p.

A director buying shares on appointment is no great cause for joy, unless the purchase is a very substantial one. Also, buying shares to take up an option that is expiring is not as significant as buying the normal way. However, if the extra shares from the option are retained, this can be encouraging.

Companies have ‘close periods’ before their results when directors cannot deal in the shares. It is useful to know the key dates, as, in retrospect, dealings about a month before close periods begin often appear to be very astute.

The easiest way to find details of directors’ dealings is to ask your broker. His screens show dealings on a daily basis and he should be able to provide details of the preceding few months’ transactions.

REFS shows the last six months of directors’ dealings in great detail together with a mass of other statistical information, including the director’s position, the nature of the transaction and the residual shareholding. (Although dealings by several directors can be an interesting investment pointer, they are no substitute for a detailed examination of the company’s financial figures and prospects.) However, when you have made a decision to buy, it is always pleasing to find that the directors agree with you and are also buying shares. Conversely, when you see that they have been unloading in a big way, it is difficult to muster much enthusiasm for a company.

2. With less mature companies, the EPS growth rate is of great importance, but the record may not be long enough to judge the management’s ability.

3. If mangers are intent upon fooling investors, the cards are stacked in their favour. Investors should try to build a picture from:

a) Annual general meetings.

c) Constitution of the board.

d) The CEO’s outside activities and lifestyle.

e) Success or failure in meeting profit forecasts.

f) Calibre of advisers.

Additionally, the attitude of employees can be a good guide. Is the phone answered quickly, do they have a sense of purpose and are they proud of their company?

4. The appointment of a new CEO can herald a major change in a company’s fortunes. Read press cuttings and profiles and try to ascertain the incoming CEO’s record of increasing EPS in his previous employment.

5. Directors’ share dealings are a useful guide to share selection. In particular a cluster of directors buying is a very bullish sign.

The position of the director and the percentage increase or decrease in residual shareholding should also be taken into account. Note that dealings just before the close period often appear to be very astute in retrospect.