I enjoy reading books on investing and human behaviour. I recently read “David and Goliath: Underdogs, Misfits and the Art of Battling Giants” by Malcolm Gladwell. In his book Gladwell is trying to explain the asymmetry of opposing forces, why the nimble win and why the large institutions can’t break small, dedicated groups of people.
A good friend of mine was talking to me about one of his and Warren Buffett’s favourite books, “The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success,” by William N. Thorndike (and a team of researchers). He loved it (as did Warren Buffett) so I asked him for a brief summary for my readers.
The book is the product of a forensic analysis of the best eight performing CEOs in America (at least in the listed world) all of whom delivered exceptional performance to shareholders during their leadership. The shortest period was 19 years and the longest (Warren Buffett) is 46 years, and still counting, so their performance was not a function of luck, these CEOs really delivered.
The companies these CEOs managed, delivered an average annual return of 21.6% versus the S&P 500, which delivered 10.2%. That’s double the return of the stock market; the long term compounding effects are an investor’s dream. For every 10 years on a pre-tax basis, the additional performance is a factor of 2.7 times.
The CEOs, while running different businesses in different industries, had a number of things in common. Probably the most notable similarity, and the one thing that really sets them apart from most managers, was their disciplined approach to capital management and their unemotional detachment to assets. They weren’t necessarily great managers in areas of product, marketing, process or people, although I expect they were at least competent. But these CEOs were outstanding capital allocators with the ability to buy when value was compelling and sell when prices were high, with little emotional or corporate bias.
Most of these managers operated independently of the day-to-day operations of their businesses, instead choosing to give high levels of authority and responsibility to managers close to the coal face, while focussing on the deployment of the organisation’s capital as effectively as possible. A ruthless focus on deployment of capital to where it would provide the most attractive, absolute (risk-adjusted) return was consistent amongst the group of exceptional CEOs.
Outside the square
As a group, they exhibited great patience and resistance to market fads and fashions. Very often, they were stringently opposed to the contemporary trend, by selling when others were buying and buying (including their own stock) when others were selling. At times, they showed supreme patience by sitting on capital for prolonged periods of time, waiting for appropriate opportunities, or giving it back to shareholders. As we know, Warren Buffett (CEO of Berkshire Hathaway) sits on tens of billions of dollars of cash, while waiting for opportunities and Henry Singleton (CEO of Teledyne) ultimately bought back approximately 90% of Teledyne stock, when the price traded at cheap levels. This approach is particularly effective in America, as Wall Street tends to under-rate companies executing buybacks, considering it a negative and reflective of an organisation with no growth options. Wall Street therefore tends to sell a stock that is undergoing a buyback. This seems counter-intuitive to us. If management believe the stock is cheap enough to buy back, then it is most probably good buying. I prefer not to sell stock into a buyback. The insiders, after all, know more about the company than anybody.
In this day and age, our investment industry appears to be moving more and more towards quantitative analysis, but if the examples in this book tell us anything, it’s that really good management makes a big difference to investment returns over time. Therefore, it’s worth analysing the quality of management and its capital management qualifications as closely as the valuation process.
The Australian equivalent to “The Outsiders” is my good friends Matthew Kidman and Alex Feher’s book “Master CEOs”. A great read.
At Wilson Asset Management, we place significant importance on the quality of management, particularly when we are looking for undervalued small to mid cap growth companies. The ones we favour currently are Andrew Grech from Slater and Gordon (SGH), Greg Shaw from Ardent Leisure Group (AAD), Adrian Di Marco from Technology One (TNE) and Shaun Di Gregorio from iProperty Group (IPP).