Professional analysts have many advantages, because they have the ability to call company officers directly, take tours and go to analyst meetings. Retail investors who are attempting to analyze a company on their own are fairly limited by way of access and information. However, there are a number of ways that the amateur investors can measure how well management is performing.

Ratio Analysis
Return on Equity
One of the first and most common ratios used to analyze a company's management is the return on equity (ROE). Investors or shareholders are the company owners, and through their representatives on the board of directors, a company president or chief executive officer is selected. As a partial business owner, you will want to know how effective your manager is with your money and you can do so by comparing the net income of the business to the number of shareholders.

Net Income/Shareholders
By dividing net income by the number of shareholders, a ratio or percentage will occur. The ratio by itself doesn't really tell you much, but instead it will give you something to compare with other investment alternatives. For instance, comparing a company's ROE to other firms within its sector is a good approach to measuring the company's competitiveness.

Return on Assets
The next ratio of importance is return on assets (ROA) which attempts to measure management's effectiveness at using the company's assets. ROE measures how well management is employing your money, whereas ROA shows how well management is employing the company's resources. This formula is also a simple calculation.

Net Income/Total Assets
This ratio is best interpreted in the context of the stock's industry group, because it's an "apples-to-apples" comparison. Some industry groups can be capital-intensive and require a lot of manufacturing and/or production equipment. Therefore, a comparison of the S&P 500 wouldn't necessarily be helpful. Assets aren't just equipment and land, but also debt and equity. If a problem arises, it's likely that money will have to be spent to fix it. Dumping money into a problem doesn't fix it - good management will make sure the money is used wisely and the ROA can tell investors how management is doing when problems arise. (For a more indepth look, check out Understanding The Subtleties Of ROA Vs ROE.)

Return on Invested Capital
The return on invested capital (ROIC) ratio attempts to measure management's ability to allocate the company's capital into profitable investments that produce returns. Capital is long-term debt and shareholder equity, including preferred shareholders. However, since shareholders may be entitled to dividends and dividends reduce net income, the ratio excludes dividends.

Net Income – Dividends/Total Capital
The ratio is commonly used to measure management's effectiveness over time, and investors should look for an ROIC of 10% or higher over 10 years. This will give investors an instant track record for management. (Learn more in Spot Quality With ROIC.)

Growth Rates
There are two common growth rates for sales and earnings. These two each tell a story of their own, and another story when combined. Obviously, higher sales and higher earnings are a good sign for the company. When looking at growth companies in the small and mid-cap range, you should expect to see the growth rates at 20% or higher. Large-cap companies will find it difficult to reach this level, because they are so big. Therefore, you will need to lower the standard depending on the size.

While seeing sales rise is an excellent sign for a corporation, if management can't turn rising sales into rising earnings, it may not matter how great sales look. This is why we also want to see that the earnings growth rate is higher than the sales growth rate. (For more, see Steady Growth Stocks Win The Race.)

Insider Ownership
Investors can determine the motivation of management to succeed by looking at the number of shares they own. The number of shares outstanding is the number of shares the company has issued to the public. The float is the number of shares that can be traded on the stock exchanges. The difference between the number of outstanding shares and the number of shares that make up the float is how many shares the insiders own. In other words, their compensation is highly tied to stock performance, motivating them to appreciate the stock prices.

Since insiders do receive a lot of compensation through company stock options, it may be beneficial to observe whether or not insiders are buying or selling. The problem comes because insiders sell for various reasons, like buying a home, purchasing a new car or sending a child to college. The selling of shares happens all the time, so insider selling isn't as great an indicator as you might suppose. However, insider buying is, because this means the insiders are actually forking over their own hard-earned money to pick up shares. If the company is rewarding them with shares on a consistent basis, there is little need to purchase shares with their own money. If they are purchasing shares, there is probably a good reason for it. At market bottoms, it's common to see a lot of insider buying but they can some times be premature. Another industry group caveat is that small regional banks commonly see a lot of insider buying just for the sake of owning the shares. (For more, read When Insiders Buy, Should Investors Join Them?)

Listening to Conference Calls
Investors will need to take some time to listen to previous conference calls and find out if there are any changes in the verbiage. Look for hesitancy in areas where confidence exuded before. However, the best indicator is to simply watch what the stock does after an earnings announcement. Often, an announcement or call will sound great, but the market will sell the stock down. Don't try to out-think the market - it's always right. If the market doesn't like the conference call and you don't know why, it is very dangerous to hang on to your position out of pride. Inserting a stop-loss order or hedging the position would be wise. (Learn more in Conference Calls: Press 1 For Investment Insight.)

It's helpful to know that your company's officers are highly motivated to increase the stock price because they are compensated in a similar fashion to you by the appreciation of share value. Finally, listening to the conference calls and monitoring market movements after announcements are a good way to see if the company is still having success. Make the measurement of management moxie part of your successful investing plan. (To learn more, check out our Earnings Quality Tutorial.)

Related Articles
  1. Forex Education

    Understanding The Income Statement

    Learn how to use revenue and expenses, among other factors, to break down and analyze a company.
  2. Financial Advisors

    5 Things All Financial Advisors Should Know About ETFs

    Discover five things all financial advisors should know about ETFs, including when ETFs may be a better choice for your clients than mutual funds.
  3. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  4. Mutual Funds & ETFs

    The Democratization of the Hedge Fund Industry

    The coveted compensations of hedge fund managers are protected by barriers of entry to the industry, but one recent startup is working to break those barriers.
  5. Investing

    What a Family Tradition Taught Me About Investing

    We share some lessons from friends and family on saving money and planning for retirement.
  6. Retirement

    Two Heads Are Better Than One With Your Finances

    We discuss the advantages of seeking professional help when it comes to managing our retirement account.
  7. Investing

    Where the Price is Right for Dividends

    There are two broad schools of thought for equity income investing: The first pays the highest dividend yields and the second focuses on healthy yields.
  8. Personal Finance

    How Tech Can Help with 3 Behavioral Finance Biases

    Even if you’re a finance or statistics expert, you’re not immune to common decision-making mistakes that can negatively impact your finances.
  9. Mutual Funds & ETFs

    American Funds' Top Funds for Retirement

    Planning for retirement in this economic and investment environment is far from easy. American Funds might offer an answer.
  10. Investing Basics

    5 Tips For Diversifying Your Portfolio

    A diversified portfolio will protect you in a tough market. Get some solid tips here!
  1. What is the formula for calculating return on assets (ROA)?

    The return on assets (ROA) calculation is used to analyze a company's ability to generate profits from its assets: ROA = ... Read Full Answer >>
  2. How liquid are Vanguard mutual funds?

    The Vanguard mutual fund family is one of the largest and most well-recognized fund family in the financial industry. Its ... Read Full Answer >>
  3. Which mutual funds made money in 2008?

    Out of the 2,800 mutual funds that Morningstar, Inc., the leading provider of independent investment research in North America, ... Read Full Answer >>
  4. Does OptionsHouse have mutual funds?

    OptionsHouse has access to some mutual funds, but it depends on the fund in which the investor is looking to buy shares. ... Read Full Answer >>
  5. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  6. How do mutual funds work in India?

    Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Cyber Monday

    An expression used in online retailing to describe the Monday following U.S. Thanksgiving weekend. Cyber Monday is generally ...
  2. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  3. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  4. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  5. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  6. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
Trading Center