If You Get to Talk to Management, Pt. 1

Editor's note: We're pleased to present David Merkel's five-part series on questions to ask the management of a public company. Check back every day this week for a new set of issues and the reasons to raise them. Today, Merkel explains the philosophy behind his approach and presents the big subjects he likes to get out of the way first.

"I am a better investor because I am a businessman, and a better businessman because I am an investor." -- Warren Buffett

One of the things I try to do in my investing is analyze the quality of a management team. Though this is a squishy discipline, if I can be approximately right in this endeavor, I can add a lot of value.

I want to share with you the questions I ask management and the reasons I ask them because I believe they're useful even if you never come face-to-face with a real live C-suite dweller. They cover six major areas:

• general topics
• financial
• competition
• pricing and products
• changing environment
• mergers and acquisitions

I try to analyze sustainable competitive advantage and the ability of managements to generate and use free cash flow, among other factors. (As an aside, in the insurance industry, I can kind of tell management quality by "feel." I have worked for good and bad managements, and I know their characteristics intuitively.) I try to see if managements are economically rational, are focused on building long-term profitability and act in the interests of the outside passive minority investors who own their shares.

Personally, I am in favor of small-shareholder capitalism. By this, I mean that small investors should have the same access to management, not least of all through quarterly (and other) conference calls held. This view is partly driven by the inadequate questions asked by sell-side analysts.

Too often, sell-side analysts focus on the short run and qualitative variables in their models. The short term is overanalyzed, so I try to look to the longer term. That means most of my questions are about strategy. I try to figure out if the managements in question are -- again -- economically rational, focused on building long-term profitability and acting in the interests of the outside passive minority investors who own their shares. Or do they act for reasons other than maximizing value for mom and pop, a.k.a. you and me?

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At the time of publication, Merkel and/or his fund was long Assurant and Allstate, though positions may change at any time.

David J. Merkel, CFA, FSA, is a senior investment analyst at Hovde Capital responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. Previously, he managed corporate bonds for Dwight Asset Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Merkel cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

Analyst Certification: All of the views expressed in the report accurately reflect the personal views of the research analyst about any and all of the subject securities or issuers. No part of the compensation of the research analyst named herein was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst in this report.

Merkel is employed by Hovde Capital Advisors LLC (the "firm"), a registered investment advisor with its principal office located in Washington, D.C. The Firm and/or its affiliates have or may have a long or short position or holding in the securities, options on securities, or other related investments of the issuers mentioned herein.