Please Find our notes of this brilliant talk on analyzing management of a company. This talk great examples from real business world. (Emphasis Ours)
William Thorndike is one of the authors that got a critical acclaim from the legends of investing like Warren Buffet and Charlie Munger. William Thorndike gives an analogy which pretty much summarises the book which is known as duplicate bridge.
A duplicate bridge is a game which eliminates the role of luck and materially tells you who wins the game.
He says that there are basically two tests which the CEOs mentioned in the book had to meet; one was absolute performance which meant that beating the S&P 500 consistently over a period of time and the second involved consistently beating the relative peer group in the performance.
He talks about a very important notion in investing which is known as capital allocation.
Capital allocation is the crucial element which separates a failed company and a successful company.
There are basically three ways of raising capital;
a) one is through use of own cash
b) second is to raise debt
c) third is to issue equity.
With the money that you raise you can basically deploy them in five ways;
a) one involves buying back your own shares
b) second involves buying other companies
c) third involves paying off the debt
d) fourth involves investing in one’s own business
e) the last one involves paying dividends.
Even if both the companies are similar in operations and return generation; their capital allocation across cycles will lead them to perform differently on a per share basis.
Capital allocation is one of the most crucial skills when it comes to running a company. The decision a company makes when there is Bull Market or Bear market pretty much defines how that company turn out to be.
The author also talks about how the popular opinion favours some of the character traits but instead he has found people who are hugely successful possessing totally different character traits.
The CEOs of very successful companies were found to have traits like Diligence, Hardworking, pragmatic, flexible, rational and analytical.
He talks about Jack Welch (was the CEO of General Electric), who had successfully beaten the S&P 500 for more than 15 years consistently. Jack Welch earned more than 3 times the money generated by the S&P 500. He talks about another CEO who is named as Henry Singleton. Henry singleton has generated returns which are 12 fold of the S&P 500.
Henry Singleton was a Mathematician who did his PHD from MIT and developed a guidance system which is still used in Airlines. He was a very successful mathematician before starting the company by the name Teledyne. He ran the company successfully but one of the key geniuses that got highlighted was the way he did capital allocation.
He was a master of share buybacks. He followed a very simple and effectively way to deal with share buybacks. He would buy low and sell high. Normally he would raise equity but when the times were tough he would buy-back the shares entirely. He bought 90% of his company’s shares when the stock markets had fallen off the cliff.
Normally corporate America would end up buying high and selling low. Corporate America has been a failure in stock buy-backs.
The speaker talks about why corporate America failed as compared to the other CEOs; he says although the strategy of share buy-backs is very simple to understand intellectually but on the temperamental level it is the most difficult thing to do.
One of the crucial pointers that the author highlights is the predictability of cash flows. He gives the example of John Malone who was an active user of debt to run his business. Debt is only sustainable if the cash flow from your business is predictable and consistent. John Malone was in a cable business which in a way was a monopoly so the cash flow was determinable and predictable (cash flow projections were uniform in the times of economic crises).
The author talks about a concept of the creation of Alumni Diaspora. The companies outlined in the book have shown very strong cultures. So the people who have worked in those companies get influenced by the culture and would carry on with the practices associated with that culture. Such cultures create a Diaspora of Alumni who go on to spread the practices elsewhere.
He also talks about a CEO named Bill Anders. He was trained as an engineer, understood aeronautics and went to Apollo mission. He started working for a company as a CEO during his 50s and immediately sold off half of the company.
The author talks about a deal where he ended up selling the business where the company commanded a very top position; he was getting a huge set of premium for the company. By selling the company he generated humungous amount of money on per share value basis. He gave dividends and with the help of an Accountant he saved a lot on taxes and after that he bought 30% of the company’s shares.
He talks about how the objective of the outsider CEOs is always to optimise long term shareholder value. In today’s time it is difficult to find a CEO who is an outsider but is able to perform like an owner operator. But there are people Colfax and others in modern times that have done the unthinkable and increased the shareholder values by leaps and bounds.
He also talks about a CEO named Mark Leonard who runs a very successful business in Canada by the name Constellation software.
He talks about some subtle things to look in the annual report.
a) He talks about finding out how much the CEOs have written per share values in the annual reports.
b) Also a key thing to note is that whether the CEO writes the letter himself. Warren Buffet has been the icon who has written each and every annual letter by himself.
c) He also talks about how one should focus on free cash flow per share rather than net income per share because free cash flow is essentially what will be of value to the shareholder. Also try to find whether the decisions that the CEO takes is shareholder friendly or not.