I recognize that there may be a perception among people who avoid Twitter that the platform represents the epitome of everything that is wrong with “social media.” Only having 280 characters to communicate your nuanced thoughts can certainly be somewhat limiting. In all honesty, I had the same conception of Twitter until I started being more active on what is known as FinTwit.

Since I re-engaged with the platform last year, I have met some really thoughtful, like-minded investors who have become true friends. Also, I have found the community members to be quite generous when it comes to making connections and introductions. Case in point is that one of my Twitter followers recommended me for Edwin Dorsey’s Sunday Idea Brunch.

Edwin, who goes by the handle StockJabber on Twitter, interviews investors and then publishes the conversation to his paying subscribers each Sunday. My interview with Edwin was published last Sunday and he generously allowed me to post an excerpt from the discussion (see below), along with a link to the whole interview.

Also, if you want to check out any previous interviews, you can access Edwin’s Substack here.

Please enjoy the following excerpt regarding Cove Street’s management assessment due diligence process.

– Ben

You have interviewed dozens of small and mid-cap CEOs on the Compounders Podcast. What are some of the common signs of a great CEO and who are some of the public company executives you most admire from your interviews?

You are right that, through the podcast, I have interviewed executives from a wide variety of industries—from insurance to software to waste management. Before I address your specific questions, I should take a step back and mention that Cove Street has three pillars within its investment process: Business, Value, and People. In my humble opinion, it is the people assessment aspect that is the hardest, and thus many investors don’t utilize all of the tools at their disposal to try to determine whether management is a friend or a foe. While there are plenty of quantitative metrics you can use to get a sense of management’s acumen, at the end of the day the process is quite subjective and qualitative. Buffett has plenty of insightful quotes about the importance of finding a great manager but being able to ascertain who is truly exceptional can be time-consuming and be prone to false positives. So, I spend a lot of my time on the People pillar within our process. In fact, each year I guest lecture to Benjamin Graham Value Investing Program students within UCLA’s undergraduate economics department about the steps we go through—an Atul Gawande-like checklist—to assess management, capital allocation, and corporate governance. (Presentation available here.)

Accordingly, the podcast is a natural extension of our investment process. I replicate the same due diligence and preparation I do for a management meeting in order to host an interview. I will say it has been a wonderful process. I feel so lucky to be able to interact with public company CEOs, both on camera and off. Hosting the podcast has deepened my relationships with the CEOs and forced me to get much better at asking meaningful questions that will elicit substantive responses.

Now, my answer to the question about the common signs of a great CEO might be a little bit too squishy for certain people. Again, management assessment is subjective and people can’t be reduced to a single score or rating. People are more complicated than that and trying to do so would lead to an incredible amount of false precision. I am partial to people who care deeply about their employees and the company—so much so that it shows when you meet them. While the mercenary CEO who comes into a turnaround and figures out how to create value for shareholders might be a great short-term solution, what I am looking for is a company that can be a compounder. (Hence the name of the podcast.) By definition, that is a company that can sustain high returns for many, many years. As an investor, I am not looking for a 50% pop so I can sell the stock and then find something else. I want to find one of Chris Mayer’s 100-baggers. And it is really hard to achieve that if you don’t have a leader who is fully invested in the company—and that includes his or her relationship with all of the stakeholders.

Let me give some examples in a way that also answers the question about the CEOs I admire. I asked Markel Co-CEO Tom Gayner about what he has learned being a CEO that he might not have learned if he had just been a public company investor. His answer was that being a CEO has made him more patient and understanding when things don’t go right. He has developed an empathy for people and that has allowed him to become a part of the Markel family, even though he doesn’t have that last name. Or, take Mauricio Ramos, the CEO of Millicom. On the podcast, Mauricio told a story about how the salespeople in the various Latin American countries where Millicom operates have different chants that they do before leaving the office for the day. Mauricio knows the chants and will do them with the salesforce. This is all part of Sangre Tigo, an initiative that brings people together from different countries and tries to make them part of the Millicom family. Lastly, Brian Recatto, the CEO of Heritage Crystal Clean, told this incredible story about how he gives out his cell phone number to the field workers who are out there collecting used motor oil. It is a hard job, and it is hard to keep people in the job. So, Brian takes calls from people when they are struggling.

You will notice that I haven’t mentioned anything about capital allocation or the ability to get people to hit their numbers. Of course, those are important. But, if you are looking for exceptional companies and to be able to enjoy riding a compounder for years, you often need more than that. I see those other elements as table stakes. Great leaders inspire people and foster a culture that allows for retention and personal growth. And when you combine those traits with great returns on capital, the ability to re-invest in the business at high rates, smart M&A, and a reasonable valuation, that can be an explosive cocktail as an investor.

I think the takeaway is that investors should look for leaders who have an unquestionable dedication to employees and customers. Anybody can—and should be able to—sit in a meeting and talk eloquently about margins, returns on capital, world-class acquisition integration capabilities, and the company’s differentiated “business system.” You should expect that if you are partnering with them. Maybe that is enough to generate respectable returns for shareholders. But I am looking for someone that has the same passion for the company that I have for investing.

In your interview with Richard Sosa, you emphasized the importance of investing in companies with good or improving culture. What are some of the ways you determine a company’s culture and what are some of the items on your red flag checklist?

Without any doubt, the culture part is the hardest aspect to put your finger on. What you would really want to do is sit for a week in the lunchroom with the company’s employees and be a fly on the wall for all of the Board Meetings. Maybe then you could be confident in your assessment of the culture. But you aren’t going to be able to do those things so you have to find other ways to make what amounts to an educated guess. I do have my own management assessment scorecard that I go through for each company. I use it as a checklist in which I try to identify outliers—either very good or very bad things. Within the checklist, there are questions about corporate governance and compensation but all of those things have some relationship with the overall company culture as well. I try to get a holistic perspective on culture and that process inevitably begins with looking at the top of the organization.

So, where do I start? An easy place to start is by reading conference calls. Does the company single out a specific employee on each call? Do they talk about safety on every single call? Do they thank their employees before ending each call? These may seem like little things, but you should take note when companies consistently do these types of things.

Next, I think the proxy statement can tell you a lot about what a company thinks is important. Compensation drives behavior and if you want to know what behaviors are valued, why not pay close attention to the details located within the proxy? Does the company reward execs for quarterly EPS growth or based on free cash flow and return on capital over a three-year period? Again, if you are looking for a compounder, you want the executives and all of the employees to be aligned around a longer-term time horizon. The proxy also has information on total compensation, perks, and execs’ golden parachute that you can use as data points.

After that, I usually turn to our friends at Tegus who source former employees for us to speak with. While you must always be aware that former employees may have some bias, I find these calls to be the most insightful when it comes to culture. If you ever read a call that I have done on the Tegus platform, you will see that the second question I ask—after the “tell me about your background” question—is about whether or not it was a good place to work. I also ask questions about the CEO’s strengths, weaknesses, and management style. One data point is never enough but if you talk to enough former employees, I think you can get a decent sense of what the culture was like.

I could go on but let me pause and say that I adhere to what I would call a mosaic style of investing. I liken the research I do on a company to painting on a canvas. Each nugget of information or data point becomes a dot on the canvas and the goal is to collect enough dots to be able to step back and eventually see your Monet. It may require a lot of data gathering before you are confident about what you are seeing. But especially when it comes to culture and management assessment, it pays to keep digging. That includes going to Indeed.com and Glassdoor and looking at reviews. It includes keeping close tabs on turnover within the C-suite. And it includes tracking management’s objectives over time. If a company is consistently missing its targets and/or moving the goalposts, the company may have a lack of accountability.

If people are interested in seeing my management assessment checklist, feel free to reach out to me. I am happy to share it. That checklist includes a list of red flags that we have found to be, at times, signs of a bad culture or a management team you don’t want to partner with. Here are some examples:

• A CEO who doesn’t even live in the city where the company is located
• Someone who treats his or her assistants and secretaries badly
• A leader with a large corporate jet allowance disclosed in the proxy
• Constant restructuring and layoffs, even in good times
• Compensation that consistently appears egregious relative to the size of the company and the compensation of its peers
• 2 pages’ worth of related party transactions in the proxy
• The majority of equity compensation is time-vesting without any performance requirements

Let me finish with what not to do when it comes to trying to assess culture. Don’t ask a CEO if the company has a good culture. The answer will inevitably be yes. Instead, ask the CEO what values he or she tries to embed in the culture and how he or she takes those values off of a whiteboard in a conference room and drives them down into the field. The best answer to that question came when I interviewed Ben Gliklich, the CEO of Element Solutions. What you want is a CEO who can talk about culture as gracefully as Ben talks about the 5 C’s within Element Solutions’ culture.