Better ways to analyze companies

Five years ago, a company went public and paid good yield.

Many top firms were underwriting it, and James Meltzer got swept up by the euphoria.

But before the Montreal-based senior vice president with Macquarie Private Wealth placed an order, he went to a presentation by the company’s executives. Rather than clinch the deal, the face-to-face turned him off.

Read: How to evaluate corporate equities

“Their entire energy seemed focused on how much money they’d pocket from selling part of their holdings in this IPO deal,” Meltzer says. He sided with his instinct and opted out.

Sure enough, the company did poorly. The IPO was priced at $10; the stock opened at $9.73 and never went beyond that; and within a year the company went bankrupt.

Richard Hart, on the other hand, was certain he didn’t want any part of Toronto-based technology company Absolute Software. Its stock—issued at $5 at the height of the dot-com boom—was trading at 50 cents eight years ago. Still, he attended its company presentation, and the CEO and CFO were brutally frank about their financial struggles.

Hart, an investment advisor at MacDougall, MacDougall & MacTier Inc. in Montreal, found that honesty endearing and bought more than 25,000 shares at 50 cents each for both his clients and himself. He chose wisely—the stock is now back above $5.

Read:

• Banks, telcos are good buys
• Delve into the tech sector: AUDIO

There are 2.4 million small businesses in Canada

Source: Government of Canada

These experiences show why gauging the aptitude, character and values of people at the helm is pivotal to assessing companies. No matter the sector or product, you shouldn’t tie your fortunes to executives who are glib or overly optimistic.

Small companies, big talk

While most advisors can only speak to management teams of large companies through quarterly conference calls, they should meet executives of smaller firms.

Body language clues

Here’s how to know a person is uncomfortable:

• Sweaty palms
• Tugging ear
• Dry mouth
• Knitted brow
• Rubbing nose
• Stiff upper lip
• Rubbing or touching eyes
• Rubbing, wringing or scratching hands

If you see these tells during a CEO meeting, probe further.

“A small company doesn’t have as many chances to make mistakes,” Meltzer says. “So get to know the top executives and their business philosophies. It’s similar to [what happens to] people who apply for jobs. You have their résumés, but you want to meet them and get a feel for what they’re all about.”

Read: All-cap approach reveals hidden gems

Meltzer once met with an oil and gas CEO who said he only hired people who invested in the company—from senior engineers to receptionists. Why? To ensure a firm-wide sense of responsibility. “That’s something I’d never have known without meeting the CEO, because it isn’t mentioned anywhere in the company’s written policies.”

Tom Burke, senior investment advisor at Canaccord Wealth Management in Montreal, also endorses personal meet-and-greets. “I like to be able to explain a company concisely to my clients. A phone conversation or face-to-face meeting with management helps me do that.”

Burke’s first step is to sift through successful firms—particularly if they’re TSX-listed and non-resource stocks—for those trading at new 52-week highs. If a company has decent volume and it’s reasonably valued, Burke picks up the phone to learn how the business works. Then he asks if the CFO or CEO is willing to meet for a chat, so he can get a sense for who’s running the company. He likes to be able to assess their attitude and body language (see “Body language clues,” right).

Burke buys small companies run by people he feels comfortable with. “More often than not, small growing companies are run by driven entrepreneurs who own a significant chunk of the company, as opposed to larger companies where salary and bonus, rather than pure share ownership, are the driving financial motivations for executives.

“The interests of the founder of a small company align much more directly with the interests of small investors.”

He also watches for orphaned or unsponsored companies still under the radar. Not being followed by Bay Street analysts often means the company is cash-rich and doesn’t need to raise money in the market.

Read: Smart investing means being steady, not seasonal

“Getting face-to-face with management in the early stages of such a company’s growth can sometimes bring fantastic results,” he says.

For ideas on what companies to follow, Burke relies on his firm’s analysts for research, and subscribes to newsletters, such as those from KeyStone Financial Publishing, that cover small- and micro-cap businesses.

Meltzer also looks at firm-recommended companies, and then meets with those that represent sectors he’s interested in.

He primarily chooses dividend-paying firms, and examines the management team’s histories with similar ventures. “Even if companies are very new, their executives often have past experience and track records you can look up.”

58% of all small businesses are located in Ontario and Quebec

Source: Government of Canada

Finally, he consults industry experts. For instance, if a medical company looks attractive, he asks doctors about its products. “That gives you anecdotal evidence of what the customers think,” Meltzer says.

Verbal and non-verbal cues

During presentations, Burke is wary of executives who talk about their company as if it’s their handiwork.

Get many opinions

Montreal advisor Tom Burke has been organizing face-to-face meetings with company executives every few months for more than 20 years. He invites not just Canaccord colleagues, but also clients and brokers from other advisory firms.

“Have a good mix of people, so opinions flow from completely different backgrounds. Sharing ideas across the street is healthy,” he says. These meetings are mostly held over lunch at a restaurant, or breakfast in a boardroom.

Even when he’s vacationing, Burke sometimes contacts a company he’d like to visit. “I just ask if I can come over and meet the management,” he says.

Read: Avoid short-sighted investing

Burke keeps eyes and ears open for interesting investment stories at any destination. When he went to Manchester, England to visit his brother-in-law in 2003, he visited Old Trafford, home of Manchester United, and took a tour of its stadium. He was blown away by the organization’s professionalism. When he returned, he crunched some numbers, researched the company a bit more, and ended up buying stock for himself and a couple of clients.

Within six months, the stock rose about 30%.

Companies may also invite you to on-site tours. Advisor Rick Hart says that lets you see how much they’re spending on vehicles, office space, etc.

“I love going to companies where they’re driving normal cars and working in warehouse-like conditions. It’s heartening to see they work hard and count their pennies carefully.”

His hackles rise when a CEO consistently uses the first person to describe an accomplishment—“I, as opposed to we. That’s one of my pet peeves. It seems like the guy’s been reading too many of his own press clippings,” he says. “I like to see a CEO who’s leading an efficient team.”

Another warning sign is when executives tell you their companies won’t be around long, because they’ll sell fast.

“I prefer the CEO talk like she’ll be running the business the rest of her life,” says Burke. “Management has much more control over growth and operational excellence than over lucrative acquisitions.”

Read: Invest in dividend-paying companies

To that end, he looks for CEOs like Stanley Ma, owner of MTY Food Group, a Canadian franchisor of quick-service restaurants such as Mr. Sub, Jugo Juice and Country Style.

Burke once asked Ma to sponsor some of the sports programs at Concordia University in Montreal. Ma agreed and, early one Saturday, showed up with his CFO and some ladders to hang posters at the campus.

“Such hands-on entrepreneurs are attentive to their businesses 24/7. And the best time to hitch your wagon to theirs is when they haven’t yet been discovered by the street,” Burke says. Indeed: eight years ago MTY’s market capitalization was around $30 million; today it’s $475 million.

In all honesty

Look for executives who play it straight.

Hart recently met representatives of a small gold company, and the CEO admitted they hadn’t drilled enough yet to know the mine’s prospects. He couldn’t even vouch for what grade of gold they’d find. But Hart remained interested because of the CEO’s disarming honesty—he wasn’t unnerved by those tough questions. “My guard goes up if I find the management diplomatic or a little too well-prepared. I’ve experienced slick dishonesty at some of these meetings, and when that happens my first instinct is to get out,” Hart says.

After the executives make the pitches, Meltzer always asks what percentage of the company insiders own. “It’s a good thing when executives say they’ve bought large positions. They’re showing confidence in the company and their abilities to run it.”

At times, Meltzer adds, people duck the question, “and when you look up the company insider reports you realize the CEO has been selling off his stock. That usually doesn’t bode well.”

He also asks smaller, listed companies: why are you public? After all, it takes a lot of money and effort to file and report.

“It’s not a good sign when a CEO says: ‘I don’t really have a good answer. It’s just the way things ended up happening,’ ” Meltzer says. “A better answer would be: we wanted more cash; we wanted to make acquisitions; or we wanted to motivate employees by offering them stock options to allow profit-sharing.”

Read more: Taste companies before buying >

Kanupriya Vashisht is a Toronto-based financial writer.