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Advanced Stock-Picking: Grill Top Brass

TSC Staff

From Goldman Does It Again With Profit Beat:

Goldman Sachs (GS Quote) posted sliding second-quarter profits Tuesday, but easily topped Wall Street's expectations tempered by the lingering credit crunch.

While Goldman's stock was flat in trading Tuesday, the firm, which had thus far escaped the credit crunch relatively unscathed, appeared to have dodged another bullet.

"Given the difficult market conditions, we are particularly pleased to be able to report strong results for the second quarter," Chairman and CEO Lloyd Blankfein said.

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Cramer: Goldman's Right Where Lehman's Wrong (Video)

Lehman Brothers (LEH Quote) is a mess, plain and simple, says Jim Cramer, and pales in comparison to Goldman Sachs.

Cramer: "I look at what Dick Fuld [CEO] did with Lehman Brothers in 2007 and it was stupid... They had to be among one of the worst lenders of 2007. Goldman didn't lend at all and Goldman played with its own capital... We tend to want to only look at Goldman and think it was only right by luck. What I'm saying is, when you're right as often as they are, maybe they're like Chipper Jones [baseball player for the Atlanta Braves ] -- maybe they're like a .400 hitter... Goldman is a .400 hitter."

To watch the full video, click the player below:

From Lehman CEO Fuld Faces His Critics:

Lehman Brothers CEO Richard Fuld put the target on his back Monday, as he kicked off the beleaguered firm's conference call to discuss its $2.8 billion second-quarter loss.

Fuld faced analysts for the first time since Lehman ousted CFO Erin Callan and COO Joseph Gregory on Thursday, three days after the firm warned of its losses. In typical fashion, the type-A Fuld took charge of the conference call from the outset, perhaps mindful he could be the next to lose his job if shareholders remain unhappy with the direction the brokerage house is headed.

"This is my responsibility," he said of the firm's poor performance of late, part of an opening speech that preceded his turning the call over to Lehman's new CFO, Ian Lowitt.

Read the full article. Plus, get up to speed with Lehman Brothers Breakdown.

How to Evaluate Management

From The Art and Science of Measuring CEO Performance:

Of all the potential metrics, earnings growth is among the most critical. "It captures how well a CEO is running the business," says Mary Ellen Carter, a Wharton accounting professor. Adds Brian Cadman, an accounting professor at Northwestern University's Kellogg School of Management and currently a visiting professor at Wharton: "Earnings is generally considered a good metric because it provides a summary measure of value added to the firm over a given period." But regardless of which specific performance metrics are used, "it is important to compare them to historical values or to a 'peer' group of firms," Cadman says.

Wharton accounting professor Wayne R. Guay says most of the financial incentives provided to CEOs and other senior executives are based on their company's stock price. "These executives hold large portfolios of stock and stock options that tie their wealth to shareholder performance pretty closely," Guay says. "For the typical CEO, that is the lion's share of the incentive."

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From Talking to Management, Part 1: The Big Questions:

Though most of us are outside passive minority investors, pretend for a moment that you are a private-equity investor. There's value to be had in understanding how an investor in the business would benefit in the absence of a secondary market for ownership interests. The value derived by a private-equity investor feeds slowly to the public equity investor in the short run but directly in the long run.

What sustainable competitive advantages do you have vs. your competitors?

As with most of my questions, I usually have a reasonable idea of what the answer is likely to be. Part of my question is to test the competence and veracity of management. If it trots out some answer that is nonsense, that is a big red flag to me.

Given that most of the time I invest in mature industries, I want to hear answers that tell me the company has an expense advantage over competitors. That can be easily verified. Other possible answers include exclusive distribution agreements, patents, technological advantages and company culture.

Once I hear the answer, I try to analyze how much it makes sense. Has the company really created a "moat" that protects its profits from competition, or is it trying to fool me? I don't always get a sharp answer, but the exercise is always valuable. Uncertainty leads to doing nothing or to a smaller position, which is always appropriate when you don't have a big edge.

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From Talking to Management, Part 2: Gleaning Financial Subtleties:

What proportion of your earnings are free cash flow, available to be invested in new opportunities, stock buybacks, or dividends?

Again, a good analyst has a reasonable feel for the answer to this question. If management oversells its ability to deliver free cash flow, that's a red flag. With companies that I am short, I often ask about when they will increase the dividend or buy back stock. Alternatively, I ask about the prospective rate of return on their new projects, but more on that in the next section. You can ask a management team outright what proportion of the company's earnings is free cash flow and then analyze that for reasonableness.

As an aside, you can stay clear of a lot of blowups by avoiding companies that have strong earnings and weak or negative free cash flow. If a company has to plow a lot of cash back into the business to maintain it, it's often a sign of costs that aren't reflected in the current profitability of the business. At the edge, big deviations can indicate fraud; for example, I avoided investing money in Enron as a result of this analysis.

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From Talking to Management, Part 3: The Competition

If you could switch places with any of your competitors, who would it be and why? Alternatively, if you think you are the best positioned, who is next best, in your opinion?

This question usually won't get an answer in large forums. It's best saved for more intimate gatherings, because to the wider investing public, most companies portray themselves as the best. Also, in diversified corporations, it's useful to ask this question of divisional heads rather than the CEO. They have a closer feel for the competition they face on a day-to-day basis.

When answered, this query can yield new research vistas. Who knows company quality better than an industry insider? The response can bring out the unique reasons a competitor is succeeding -- and, potentially, what this company's current management team is doing to challenge the competitor.

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From Talking to Management, Part 4: Prices and Products

Do you have any complementary products in the works that open up new markets for you?

Much of the time, growth happens through a willingness to explore offering products and services that are one step removed from existing offerings. This could be a new marketing channel, offering the product internationally, extending the brand, offering services that complement the product, etc. Often a move like this precedes growth in profitability; it means that executives are looking for low-risk ways to expand the franchise.

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From Talking to Management, Part 5: Understanding Major Shifts:

What do you think is the most important change happening in the competitive environment at present?

This query can highlight emerging issues and demonstrate how the company is adjusting to the changes. Again, you need to compare the answers of various managers against each other; an odd answer could either be ahead of the pack or out of touch. If you think the answer makes sense, it can open up new questions that further enhance your understanding of the industry and the role that the company you are interviewing plays in it.

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Need help with some financial jargon, visit TheStreet.com's Glossary.