The Best Way to Measure the Quality of ManagementWhat is the single most important item that directly determines long-term value, a company’s stock price and the creation of shareholder wealth?
It is not earnings or dividends. It is free cash flow on a per share basis and the higher it is over time, the higher a company’s stock price will be.
Free cash flow on a per share basis is directly impacted by the capital allocation skills of a CEO. In fact, capital allocation is the CEO’s most important function. Shareholder wealth is directly impacted by the degree of logic and skill that the CEO employs in his or her capital allocation duties.
There aren’t that may options to choose from when allocating capital. There are only five:
- Reinvest in the Company
- Pay down debt
- Acquisitions
- Buy back stock
- Dividend
If you were to create two identical companies, identical in every way imaginable, but have two different capital allocation strategies, well you would have two very different companies over time and one of them would have a much higher stock price than the other depending on the CEO’s capital allocation strategy, logic and skill that was employed.
Over the next few weeks, I’m going to write a series of posts. Each individual post will be a case study of an actual company and look at their capital allocation practices and how well its stock performed.
There will be four case studies in all – one every week or so. This is the best way to measure the quality and level of competency of any management.
I think you will find these case studies very illuminating.