I recently read The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success by William Thorndike. This is a must read book for investors and executives alike. It dispels many notions about what makes a successful CEO and also brings to light how uncommon common sense is in corporate America. Despite running fundamentally different businesses and having unique backgrounds, the similarities among the eight CEOs profiled were striking.
Key approaches / characteristics shared by the CEOs profiled include:
- Capital allocation was the most important role of the outsider CEO; the outsider CEOs quickly exited low return businesses, invested heavily in high return businesses, and made acquisitions/repurchased shares only when the price was right and prospective returns met specified hurdles
- Leverage was universally employed to make acquisitions or repurchase shares; when the price was right, the outsider CEOs bet big and weren’t afraid to borrow substantial funds to do so
- A fanatical approach to cost controls; the CEOs always had a strong COO at their side to prudently monitor cost and right size operations; shareholder funds were rarely, if at all, spent on lavish offices or costly travel policies; the ships were right sized to the max which is why you rarely saw these CEOs undertake “cost cutting” or “restructuring” initiatives – there simply was no need or room to improve
- Extreme decentralization; the CEOs believed in allocating authority to the business units almost to the point of ignorance; this had the effect of motivating and retaining highly talented individuals; the CEOs realized very early on that talented people want autonomy and authority more than money; Charlie Munger always talks of Berkshire’s “seamless web of deserved trust”
- The CEOs were not focused on the key metrics Wall Street is focused on: growth in revenue and growth in earnings per share; they were focused on cash flow, market share, returns on capital, and increasing value per share over time; they had a deep understanding that value per share could be increased at above market rates through adroit deployment of retained earnings and prudent use of leverage
- They prided themselves on inactivity, but prepared constantly; most of the CEOs (with the exception of John Malone and Henry Singleton) made very few acquisitions, but when they did, the acquisitions were large in relation to enterprise value; in some cases, ten years went by before a CEO would make a meaningful acquisition; similarly, share repurchases were only made during severe bear markets or sharp corrections in the company’s share price; these CEOs did not engage in automated share repurchase programs nor did they pay dividends
- The CEOs did not have an investor relations department, refused to talk to Wall Street analysts, provided no forward guidance, and spent zero time on the road speaking to investors; they focused all their time looking for high return opportunities to deploy shareholder capital
Buffett says that he’s a better investor because he’s a businessperson and a better businessperson because he’s an investor. In fact, the CEOs profiled approached their business like a shrewd investor would approach his or her portfolio. They made infrequent, but large bets, cut their losers quickly, let their winners ride, and studied all the time, waiting patiently for the right opportunity to surface. A great majority of companies today don’t have a rational policy for capital allocation. Many cash rich companies have automated share repurchase programs or make a barrage of acquisitions, irrespective of price. These managements destroy a lot of shareholder value in the process.
A great recent example of how management can add substantial shareholder value is the Daily Journal Corporation, chaired by Charlie Munger. Profits at DJCO have been flat to declining over the past five years, yet the stock is up 260% (compared to 80% for the S&P 500). How is this possible? Munger had all the company’s cash (no dividends paid, all earnings retained) in treasuries for many years leading up to the financial crisis. Then, in late 2008 / early 2009, he deployed substantially all the company’s cash into Wells Fargo and U.S. Bancorp stock. A massive, infrequent bet resulting from patience and prudence in the past created a bonanza for the shareholders of DJCO.