Investigating a company’s management is difficult. A conservative investor would do well to keep following two thumb principles in mind when analyzing investment opportunities arising out of bad news by a company’s management.
1) The Cockroach Theory: It is a market theory that states that when bad news is revealed about a company there is usually many more around the corner. This comes from the common belief that when a cockroach is spotted in a household, it is likely that there are many more in the vicinity.
2) Murphy’s law: It is pretty simple and straightforward compared to the former, it posits that whatever can go wrong, will go wrong.
Since investing is an imperfect art and it is impossible to state anything with certainty, investors would do well to think probabilistically to ascertain possibilities of thing going more wrong with the company.
For example, If a company’s management has been accused of fraud, then in all likelihood it is possible that the fraud has been happening for years and not a one-time thing.
On the other hand a factory being shut down due to worker protests could be a major event but the probability of such events impacting a major manufacturing company for the long term is pretty low since managers usually try to solve such issues by entering into contractual agreements with trade unions on new terms of operations and not just a non-written understanding of sorts.
Follow these two thumb rules while investigating the management’s integrity.