In some respects, corporate management seems to be a bit like the weather - everybody talks about it and everybody agrees it's important, but nobody can ever seem to quite figure it all out. More to the point, only a momentum investor or chartist would likely even try to claim that management does not matter when assessing a stock merit's. Yet even value hounds have a hard time assigning value to management, or even proposing how such a thing could be measured. (For more, see Putting Management Under The Microscope.)

IN PICTURES: Learn To Invest In 10 Steps

Great Management Sees the Future
In 1998, Finland's Nokia (NYSE:NOK) was the world's largest cell phone maker and Apple (Nasdaq:AAPL) was struggling to right itself just over a year into Steve Jobs' return to the company. While Apple developed breakaway winners like the iPod and the iPhone, Nokia introduced lead balloons like the N-Gage. Worse still, Nokia seemed to make the decision to play it safe and follow the market instead of looking out ahead of the curve and anticipating what customers would want. As a result, while Nokia is still the largest phone company in the world, Apple has jumped ahead both in revenue and in how much investors will pay for that revenue (Apple is over nine times larger in terms of enterprise value).

This is relatively common occurrence in business, and a major axis around which management value revolves. It is incredibly difficult to succeed by forever playing catch-up or hoping to take an already proven idea and execute it just a little bit better. The CEOs of companies like Microsoft (Nasdaq:MSFT), Intel (Nasdaq:INTC), Wal-Mart (NYSE:WMT) and Nike (NYSE:NKE) saw a future that other CEOs could not see and they positioned their companies accordingly - building billions in shareholder value along the way.

IN PICTURES: World's Greatest Investors

Allocates Capital
Product development and marketing is not the only, or even the most important, job of management. Management is also preeminently responsible for allocating a company's capital. If management wisely feeds high-return projects and chokes off (or milks) low-return businesses, the business will thrive.

Supposedly Apple spent around $150 million to develop the iPhone, a product that produces billions of dollars in revenue per year now. What if Apple had allocated that to a gaming system to rival Microsoft's Xbox? Alternatively, what if Microsoft had allocated just some of its multi-billion dollar annual R&D budget to a smartphone concept five years ago? Ultimately, how and where a company spends its money determines whether any particular management's view of the future has a chance of coming true.

Also consider the case of conglomerates and Berkshire Hathaway (NYSE:BRK.A). Typically conglomerates trade at a lower valuation than the sum of the parts would imply - a so-called "conglomerate discount" that recognizes that most management teams make suboptimal decisions and misallocate capital over their unwieldy collection of businesses. Under Warren Buffett's leadership, however, Berkshire Hathaway trades at a premium to many well-run and profitable insurance businesses due in part to his reputation as a top-tier allocator of capital.

And Executes the Plan
Brilliant plans are all well and good, but there is also undeniable value in management teams that are capable of executing the plans they create. Since 1995, Nucor (NYSE:NUE), AK Steel (NYSE:AKS) and U.S. Steel (NYSE:X) have all basically been in the business of selling steel - and yet, Nucor has done substantially better for its shareholders over that timeframe. Moreover, Nucor has returned more than the S&P 500, and that is something that materials companies aren't supposed to do. A lot of this can be laid at the feet of the operational excellence of Nucor's management.

Likewise, it is difficult to say that the differences in the fortunes of Boston Scientific (NYSE:BSX) and St. Jude (NYSE:STJ) can be chalked up solely to different visions or plans. Both companies have had to navigate significant slowdowns in their core markets (pacemakers and ICDs), competition, and changes to insurance reimbursement and FDA policy. Yet, St. Jude has shown itself to be far more adroit in navigating this tricky market. (For more, see The Ups & Downs Of Biotechnology.)

The Right People Are Worth Billions
Taking a step back, investors need only consider the fortunes of McDonald's (NYSE:MCD), Burger King and YUM! Brands (NYSE:YUM) - or Southwest Airlines (NYSE:LUV) versus practically the entire airline industry - to see the ultimate value of good management. There was no obvious or inherent reason that McDonald's and YUM should have emerged as global giants in quick-service restaurants, while Burger King is little more than an afterthought. Instead, McDonald's and Yum prospered because they had management teams with clear and far-reaching visions, sound capital allocation priorities and the ability to execute on their plans.

Likewise, Southwest Airlines was regarded as a joke when it launched with its air hostesses in hotpants and go-go boots. Now Southwest is second only to LAN (NYSE:LFL) in terms of market cap in the airline industry and has not gone through the serial bankruptcies of its rivals. This was not the product of chance. Southwest had a distinct vision (low-cost service to under-utilized airfields), disciplined capital strategies (using older aircraft) and solid execution (including excellent customer service metrics). (To learn more, Is That Airline Ready For Lift-Off?)

The Bottom Line
Since Apple's CEO took another medical leave of absence and Google's (Nasdaq:GOOG) CEO stepped down, those two companies have lost billions in market capitalization. Even allowing for the general decline in the market during the same time, both stocks have lost more than they otherwise should; suggesting that investors realize that those prior CEOs were worth potentially billions to shareholders.

Looking around the board, that seems like a reasonable assessment. After all, top-flight management can fairly be expected to produce at least a few extra points of return on invested capital relative to industry averages. Leverage that over a few billion dollars of invested capital and a few years, and the differences in profits, free cash flow and investor value add up very quickly.

Simply put, the question of whether your company has great management may very well be a billion-dollar question. Over time, companies whose managers excel in seeing the future of their industry, allocating capital to the right projects and prospects, and actually running the business with disciplined efficiency ultimately create valuation gaps over their rivals that can be measured in the billions of dollars. That, then, is certainly justification for investors to go the extra mile and ferret out those companies led by top-notch management teams, and particularly those that are not yet widely known and appreciated by Wall Street institutions. (For more, check out The Power Of Steve Jobs.)

For the latest financial news, check out Water Cooler Finance: Google Shakes Things Up.

Related Articles
  1. Fundamental Analysis

    The Basics Of Corporate Structure

    CEOs, CFOs, presidents and vice presidents: learn how to tell the difference.
  2. Personal Finance

    Top Factors Preventing Workers From Being Promoted

    Many employees blame office politics when they fail to get promoted, but they may be sabotaging their own careers with these behaviors.
  3. Professionals

    Career Advice: Investment Banking Vs. Corporate Finance

    Read an in-depth review and comparison of a career in investment banking and a career in corporate finance, with advice about which one to choose.
  4. Entrepreneurship

    START-UP NY: How a Tax-Free Zone Would Work

    START-UP NY is an initiative designed to attract companies to New York State by giving them 10 years of tax breaks. Sounds good, but is it a success?
  5. Economics

    Explaining Silo Mentality

    A silo mentality occurs when certain departments in an organization do not share information or knowledge with other departments.
  6. Investing

    Measuring Job Satisfaction in the Millennial Age?

    Generation Y embodies the trend towards meshing office life with play, and is creating a new and unique work/life balance.
  7. Investing News

    A CEO as U.S. President: What's the Disconnect?

    Can business leaders effectively lead the country's highest office? Next year may mark the first time that we'll find out.
  8. Professionals

    8 Justifications For Sky-high CEO Salaries

    Why are CEO salaries so astronomically high? There may be more to the story than you think.
  9. Stock Analysis

    Drugmaker Extraordinaire: How Eli Lilly Grows

    Drugs mean big profits in America. Here's how the country's oldest pharmaceutical firm keeps its toehold in the market.
  10. Professionals

    Are Stock Buybacks Always Good for Shareholders?

    Stock buyback programs aren't always done with the interests of shareholders in mind. It's important to try to understand the motivation behind such moves.
  1. How do you conduct effective social responsibility training?

    One way to provide employees with effective social responsibility training is to base training sessions on resources offered ... Read Full Answer >>
  2. Why is social responsibility important to a business?

    Social responsibility is important to a business because it demonstrates to both consumers and the media that the company ... Read Full Answer >>
  3. How important are business ethics in running a profitable business?

    A number of factors play a part in making a business profitable, including expert management teams, dedicated and productive ... Read Full Answer >>
  4. What advice does Howard Schultz offer would-be business moguls?

    Starbucks CEO, billionaire and former sports tycoon Howard Schultz has several pieces of advice for would-be moguls and, ... Read Full Answer >>
  5. How does brand image and marketing affect market share?

    A company's marketing efforts have a direct impact on sales and market share, but they are not the only factors that influence ... Read Full Answer >>
  6. What is Tim Cook's managerial style?

    Tim Cook's managerial style could be broadly defined as democratic. Rather than standing in complete contrast to former Apple ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  2. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  3. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  4. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  5. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  6. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!