| Small & micro cap insight

A niche screening technique: Research the new CEO’s track record

by | Oct 24, 2019

Every time a company (under $2 billion market capitalization) appoints a new CEO, we research the track record of the CEO. This is a core research conducted by our team.

It is not a “magic” screen, which others are not aware of. Many fund managers review companies that have experienced a “management change”.

With large cap stocks, the track record of the CEO gets the attention of both Wall Street and the media. When CSX appointed Hunter Harrison as CEO, almost all newspapers and TV channels talked about his track record. On the announcement of his appointment as CEO, the company’s market cap increased by a whopping $8 billion. Yes, $8 billion of wealth was created overnight by the news of his appointment as CEO.

This is hardly the case with small and micro-cap stocks. For most micro/small cap stocks, the announcement of a CEO appointment is limited to an 8-K filing.

So, what is the point?

Well, in my opinion, this provides an opportunity. Every year, hundreds of new CEOs are appointed. CEOs who have an A+ track record get hidden among others. By uncovering an excellent CEO, you can uncover a great investment idea.

First of all, successful fund managers notice signs of “information edge” that are often too subtle for others to see. The ability to “see” what others are “not seeing” gives them a competitive advantage. I strongly believe that uncovering the fact that a newly-appointed CEO has an excellent track record is an information edge.

Secondly, the newly-appointed CEO is not a magician that is able to bring changes in the blink of an eye. It takes time to fix things. The CEO’s impact can be noticed only in the long run. So, this provides ample time for value investors to research the stock.

Example

In May 2016, eHealth appointed Scott N. Flanders as CEO. Here is the summary of his track record, at the time of his appointment: (a) During his tenure as CEO of Playboy Enterprises, the stock price increased 100%; he outsourced publishing operations except for editorial, and downsized the organization by reducing the headcount by over 70%. (b) During his tenure as CEO of Columbia House, the company was sold for an undisclosed amount. (c) He co-founded an e-commerce company, and it was acquired for $4 million in 2000.

Since his appointment, i.e. in the last 3 years and 6 months, eHealth’s stock price has increased by more than five times. In fact, most of the stock price appreciation happened after only a year of his appointment.

To be clear:

  • Even though a new CEO with an excellent track record does not guarantee improved company performance, the appointment greatly increases the odds of improved performance.
  • A company that has appointed a new CEO is not a “strong buy” – it is a strong signal to research the stock.
  • A top-performing CEO is not going to accept a random position. So, accepting a CEO role by a proven executive is a vouch for the company’s future potential.

In a nutshell, the core logic is this: investors can increase their odds of success by researching companies that have appointed a stellar CEO.

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