How Well Should You Know Your CEO?

Includes: BRK.B, FB, GE, JPM, KO, PFE, XOM
by: Adam Aloisi

There's an amazing amount of blind risk that people take on a daily basis. Two million travelers get onto a plane each day without knowing anything about the two pilots sitting in the cockpit. Ailing patients get prescriptions from physicians assuming they're getting the right elixir, then go to a pharmacy and again assume that the bottle is being filled with the right pill.

While retail investors' lives are not in peril when making portfolio decisions, I'd argue that the blind faith that some put into corporate management is somewhat startling considering their hard earned money that's at stake. Some of you may put a lot of time and effort into researching company fundamentals, financial statements, and dividend history, but how much time do you put into learning about the individual running your company? Can you even name the CEO or CFO of all of the companies you own?

High Society

Some executives have attained a higher level of visibility than others simply because of built-up reputation or corporate size. Berkshire's (NYSE:BRK.B) Warren Buffett, General Electric's (NYSE:GE) Jeff Immelt, JPMorgan's (NYSE:JPM) Jamie Dimon, and Facebook's (NASDAQ:FB) Mark Zuckerberg are some household names investors have grown well acquainted with over the years. Most of us know them regardless of whether we own shares in their companies. But do you know who's currently running the show at Coca-Cola (NYSE:KO), Pfizer (NYSE:PFE), or even $400 billion oil giant Exxon Mobil (NYSE:XOM)? The answers are Muhtar Kent, Ian Reed, and Rex Tillerson, respectively -- names more versed investors might be familiar with, but certainly not household variety persona.

Jamie Dimon

Jamie Dimon

How Much Power Does a CEO Have?

While some might argue that the CEO's role is more figurehead and managerial than functional in nature, comparable to say the President of the U.S., it's difficult to make any sort of blanket statement. Dependent on the company, CEOs can, and do, wield significant policy and financial influence over corporate operations. There are others that maintain a more passive role or are put on a tight leash via corporate rules or by the board of directors. As a system of checks and balances, board of directors are meant to act as safeguards against executive misconduct and malfeasance, but critical investors (like me) may see them serving simply as rubber stamps for CEO activity.

I'd opine that the smaller the company, in general, the more influence a CEO has over its day to day operations and ultimately its success (or failure). Therefore, all the more reason for investors to be highly acquainted with small-cap management. In multibillion-dollar enterprises, there is typically a global maze of executives and middle managers directing operations on various levels, whereby the importance of any one person, even the CEO, is watered down. In smaller companies with less personnel and a more concentrated executive and business structure, the CEO may have frequent interaction with clients, customers, suppliers, and even rank-and-file workers. CEOs of larger operations may be clueless as to what is occurring beneath them.

Take last year's trading scandal at JPMorgan. Despite the magnitude of the loss and the criticism placed on Jamie Dimon, he was able to remain somewhat insulated from the fallout. Given Morgan's size, Dimon was able to claim ignorance and label the situation "sloppy" and "poorly monitored," but deflect fault in the matter. Chief Investment Officer Ina Drew, among others, was blamed for the blunder and resigned from the company. Had a similar loss occurred at a smaller financial firm where the CEO was closer to the situation, I doubt they'd have avoided the fallout. Dimon may be deemed one of Wall Street's sharpest financial guys, but as a JPM shareholder following the fiasco, I have to wonder how much of a handle he and other money center bank CEOs have on mid- to upper-level operations at their companies.

Jeffrey Immelt

And look at General Electric, whether you like or dislike Jeff Immelt, he has an army of executives presiding over a large handful of disparate divisions. Considering the depth of GE's business, do you really think he has a complete handle on what's going on at GE Capital or any of his other divisions at any given point in time? Bottom line, I feel there's an inverse relationship between the size of a company and the overriding impact and control the CEO has on operations. So while it may be fairly easy to get a read on the CEO of a large company, I wouldn't spend an inordinate amount of time evaluating the merits of a Muhtar Kent or Ian Reed. However, I think I would spend a bit more time trying to figure out if the CEO of a $100 million pharmaceutical upstart has the skills to turn the company into a billion dollar enterprise.

Getting to Know You, Getting to Know All About You

Since it's virtually impossible for retail investors to get a one-on-one with corporate management, what's the best way to get a feel for executive ability besides reading the generic website bio? Number one would be track record. How well has the company fared with the current CEO or management team? While it may be most convenient to look at stock performance, I wouldn't pay too much attention to it, especially if the CEO hasn't been around for long. Examine historical earnings growth and management effectiveness ratios including return on assets and return on equity since the individual has been at the helm. And for a more precise gauge of how management is performing, compare those stats to other companies in the same sector.

Another good way to get a feel for management is to listen in on quarterly corporate conference calls, especially the Q&A session with sell side analysts. I like doing this to gauge how skillfully and articulately executives handle impromptu questions, hopefully of the hardball variety, from Wall Street sharks. If you can't listen in, read earnings call transcripts that are posted here on Seeking Alpha.

While there's always a bit of blind faith involved in equity investment, I would suggest it's well worth your time spending a bit of your due diligence on corporate management, especially leaders of smaller-sized companies. Though you may not end up knowing everything about them, it may help turn your blind faith into something a bit more clear.

Disclosure: I am long BRK.B, JPM, XOM, GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.