Blog : Pricing the People Factor

by Ed Zwirn on November 20th, 2013

The current bull market for many penny stocks is being fueled by a great deal of investor money chasing after a lot of bright people with bright ideas. All you need is a better mousetrap, the saying goes, and the world will beat a path to your door.

But we all know it's much more complicated that that. An idea is only as good as its execution, and that depends largely upon the talent and dedication of individuals. Human capital is almost always the largest monetary outlay for a company in any given year, so it stands to reason that the people factor can often serve as the best predictor of company success or failure.

My colleague Peter Leeds has pointed this out many times in his books, interviews and posts. Part of the due diligence involved in a penny stock investment is a hard look at company management. This means getting your hands on anything accessible about the resumes of senior management, their stakes in the company and even tidbits of CEO personal lives (e.g., a messy divorce proceeding).

Of course, business analysts from time immemorial have recognized the importance of talent to the success of an organization, particularly a small business just getting off the ground.

The news here is a study I just came across which purports to quantify the people factor and its effect on stock prices. According to Mercer, a consulting arm of Marsh & McLennan Companies, human capital can account for up to 15% of an analyst's valuation.

Penny stock investors should bear this in mind when assessing a company and its prospects. Since the Mercer study sample consisted of companies with a high degree of analyst coverage, the number probably comes significantly under any assessment of the effect of human capital on smaller companies flying under the radar.

Think of it this way: Nobody is going to lose much sleep over the departure of a key Wal-Mart executive, knowing full well that this Dow Jones Industrial Average blue chip company should be easily able to find a replacement and carry on its high volume business. This is not the case with many penny stocks, which are much more reliant than the big boys on the people they have hired to carry out innovative schemes.

Shareholders and other people with a stake in a company are often left to rely on their "gut" when assessing a company's executives and overall talent pool. But because "guts" are subjective, slimy things, recognizing the human factor and taking a good look at the people to whom you're sending money is a good way to get a leg up.