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No. of Recommendations: 5
I tend to seek out stocks that have excellent fundamentals yet low valuations. Whenever I find such a stock, the answer to "why is it so cheap?" is usually "because of management".

Standard and Poors gives each stock an "insider activity" rating. This isn't strictly a "management quality" analysis, but simply an indication of whether top management is buying or selling shares. It is a "fundamental" indicator that appeals to the technical analysts because it ties in with their world view that stock prices are manipulated by an elite cognizenti and if you could be in on the inner thought circles, you too could rule the world (if the gnomes of Zurich will let you).

But using the S&P insider rating in backtesting, I have found it to be about as worthless an indicator of future share price as anything. In other words, company insiders are worse at predicting future share price than professional money managers, who in turn are worse than monkeys throwing darts at a board.

Even among those who attach a great deal of weight to management, "management" is poorly defined. The closest Warren Buffett can come is to look at how much "value" management has added with retained earnings. But "value added" is a factor of market cap, so the higher the share price, the better management has been.

This seems to be everyone's answer. If share prices are high, management is good. If share prices are low, management is bad.

Right now the best performing stock in my port is Nucor (NUE). It's selling for $46 and I'm averaged in at $26. When I was buying shares in the low 30's, the take on the Fool message boards was that NUE was cheap because management is bad. In NUE's case, the previous management was the darling of the investment world (Peter Lynch devotes chapters to it). When that management left, it was obvious that any replacement would be inferior and the stock started a sharp skid. Warren Buffett even sold his shares. But the new management isn't inferior. It's just different. And the company itself is still vastly superior to the other steel stocks. It's taken The Street a while to adjust to this concept.

In the real world, we can look at Casey Stengel, who was the greatest manager in the world when he was in charge of the Yankees and the worst manager ever when he was in charge of the 1962 Mets. Again, "good management" is usually defined as winning.

But a high share price isn't the win. Good company fundamentals are the win. The stock price is simply a reflection of the point spread that Vegas is willing to put on your continued success. Saying "JAKK is bad because it slipped from 30 to 7" is like saying "the Lions suck because the point spread in Sunday's game went from 1 to 10". Maybe, maybe not.

I accept the idea that management is the most important aspect to a company. Without competent, trustworthy management, you might as well throw your money down a sewer than invest in the market. But nobody has ever come up with a quantitative definition of "superior management" that I've found useful in the prediction of future share prices. And any such quantitative definitions are usually a function of the already existing numbers. So you could say "management is good if ROE > 20%". Well, fine. Then just look at the ROE.

It probably doesn't help that when I went to business school, my Management teacher was the world's biggest pimp for America West Airlines. The fact that they handed out stock options to employees was revolutionary at that time and we were required to write lengthy papers explaining why AWA would eventually rule the world. I was the only one in that class that noticed that AWA had a debt to equity ratio of 1300% and recommended avoiding the stock at the expense of my grade. A few years after I graduated, the stock was selling for 25 cents per share. So I'd rather have good numbers over "good management".

I'm averaged into JAKK at 9 and I'm content to hold onto my shares. I have no doubt that JAKK will one day be a $50 stock, but I haven't a clue how long that will take or whether it will dip down to 5 first.

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