Warren Buffett (Trades, Portfolio) has always placed a lot of emphasis on the quality of a company's management when evaluating its potential.
For Buffett, a high-quality management is far more important than many other qualities. A high-quality management can deal with more problems, overcome threats, fight off competition and make sure the company is reinvesting profits where it matters to reinforce its competitive advantage.
Based on the available evidence, it would appear as if the Oracle of Omaha learned this vital lesson in the first few years of his career.
Buffett's early career
When he set up his investment partnerships in the late 1950s and early 1960s, Buffett spent his time trying to seek out the market's most undervalued companies. He wanted to buy investments that were trading at a deep discount to his estimate of intrinsic value for the business.
During this period, some of his most successful investments were Sanborn Map, Dempster Mill and Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). All three of these companies had attractive assets, but their managers didn't know how to use them. So when Buffett arrived on the scene, he pushed for change.
At Sanborn, he fought the management to divest the company's investment portfolio. At Dempster, he brought in a new manager to turn the business around. At Berkshire, he kicked out the company's existing manager and took over the business himself.
Another lesser-known example was Philadelphia and Reading Coal and Iron P&R. This was described in Buffett's 2001 letter to shareholders as "an anthracite producer that had excess cash, a tax loss carryforward, and a declining business."
P&R and Fruit of the Loom
Buffett invested in the above-mentioned business in 1955, when he was working at the Graham-Newman Corporation, which controlled P&R.
P&R purchased the Union Underwear Company, which produced Fruit of the Loom underwear. Fruit became the group's largest division. It went on to achieve pre-tax earnings "exceeding $200 million."
Buffett explained in his letter that the company's success was primarily down to the management of one man:
"John Holland was responsible for FruitÃs operations in its most bountiful years. In 1996, however, John retired, and management loaded the company with debt, in part to make a series of acquisitions that proved disappointing. Bankruptcy followed. John was then rehired, and he undertook a major reworking of operations. Before JohnÃs return, deliveries were chaotic, costs soared and relations with key customers deteriorated. While correcting these problems, John also reduced employment from a bloated 40,000 to 23,000. In short, heÃs been restoring the old Fruit of the Loom, albeit in a much more competitive environment."
In 2001, Berkshire offered to acquire Fruit out of bankruptcy on the condition Holland stayed with the business. This is once again an example of how much importance Buffett has always placed on having a good manager in the right position. As he stated in the 2001 letter, "To us, John and the brand are Fruit's key assets."
Focus on the managers
Good managers can make or break a business. Still, in a world that is increasingly obsessed with making quick profits and generating attractive sound bites, it's very easy to overlook this key factor.
Good managers are few and far between. Finding them in the first place is challenging. What's more, unlike Buffett, individual investors cannot demand they stay on indefinitely to operate a business. We can only accept the decisions of management and factor these decisions into our own analysis.
Buffett has a huge advantage over the average investor, but that doesn't mean we shouldn't consider the quality of a management team before we invest.
It all comes down to how confident one feels about a business and its prospects. If it's challenging to get onside with management, who are running the business on a day-to-day basis, it might be best to avoid the stock.
