VirTra Systems: When Compensation Matters

After my recent blog post on why management’s compensation matters, I’ve been wanting to give a more concrete example. VirTra Systems (VTSI, $0.11) is a company that I was initially very interested in—great product, sales are ramping up and tailwinds to continue that growth. Unfortunately, when I delved into management’s compensation it was an absolute deal breaker.

Business overview
Let’s take a step back and look at what they do. VirTra makes combat simulators for police officer and military training. They offer simple single-screen virtual shooting ranges all the way up to a 300 degree, five screen combat simulator that fully immerses the officer in a real life scenario. These scenarios are filmed with real actors (some competitors use CGI) and then played back on the video screens for the officers. Whoever is training the officer watches and alters the scenario based on the officer’s actions. So if the officer adequately talks down the offender the scenario will go one direction. If the officer pulls out his gun the offender will react much differently. Officers also get an electronic shock when fired upon to increase realism. Below is a picture that shows their largest simulator.
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Compensation Matters

Perhaps the most important rule in management is ‘Get the incentives right.’
— Charlie Munger

If you don’t know, Charlie Munger is Warren Buffett’s long-time partner and Vice-Chairman of Berkshire Hathaway. And if you haven’t read his book, Poor Charlie’s Almanack, I cannot recommend it enough. It’s more about psychology and general life advice than it is investing, but it nonetheless had a major positive effect on my investing career. Mr. Munger ends his book with a discussion of 25 psychological tendencies he feels are the most common sources of human misjudgment. The first one on his list, because he feels it’s the most underestimated, is what he calls “reward and punishment superresponse tendency.” In more normal speak, “incentives are extremely powerful.”

On a regular basis I am shocked at how many investors will write about a company and not mention management pay. It is one of the first things I look at and is, in my opinion, one of the most important (and overlooked) parts of an investment thesis. It is human nature to be selfish and act in one’s own interest and many CEOs are incentivized not to act in the best interest of shareholders.
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