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Which way should investors jump when company management changes?

I HAVE observed over the years that one of the best ways to make a healthy profit from individual stocks is to buy beaten down companies upon news of a management change.

A fresh pair of eyes on a business often allows a company the opportunity to enter into a major restructuring plan, dispose of poorly performing operating subsidiaries and re-focus on the more profitable divisions, therefore cutting costs to improve margins and in turn, profits.

However, this is usually the easier part of the investment decision. Often new management takes charge, announces a profit warning, thereby "kitchen sinking" the numbers, only to report a substantial improvement over subsequent quarters.

The best recent example of this was with Royal Dutch Shell which had truly awful figures in the final quarter of 2013, only to report a substantial rebound in earnings three months later as it stepped up the pace of a disposal programme that appears to be gathering increasing momentum even as I write.

It tends to get a little more difficult once new management has picked all of the low-hanging fruit and has to grow the business, but by then investors have usually made a good return on their investment and if they choose to take profits at that point that is a perfectly sensible strategy.

The flipside of this scenario is one that investors have learned from the hard way in recent years, when high-profile chief executives retire at the end of a highly successful period with their company.

For example, both Terry Leahy at Tesco and Marjorie Scardino of Pearson ended their respective careers with their businesses in great shape, but ahead of what also proved to be a materially more difficult period, as incoming management found it impossible to repeat the success of the previous incumbent.

In the case of Tesco, it has taken quite some time for the current price war to develop, and there is of course no suggestion that Mr Leahy knew just how difficult a job he was passing on to his successor.

However, he could well have surmised that there was little likelihood of an improvement in the prospects for the crucial UK food retailing division, having already captured an eye-watering 30 per cent market share during his years at the helm.

The question is whether investors should shoot first and ask questions later, ie follow the chief executive out of the door and sell their shares straight after the announcement, purely on the basis that this might be as good as it gets.

Perhaps this is far too simplistic an approach, but there seems to me little doubt management change should at least lead investors to question whether they should continue to hold a stock that has performed really well over many years and is now faced with an uphill battle to maintain past glories.

Tim Gregory is head of global equities at Psigma Investment Management

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