Hallmarks of superb companies
I think you can identify those pretty well
When you boil it all down, the three most important factors to identify a superb company are: 1) Its ability to generate growing owner earnings; 2) The company’s business franchise and moat; and, 3) Management. If a company doesn’t have the first feature, it’s not worth looking further.
The problem is that if you find a potential company to invest in that looks wonderful on items 1) and 2), poor management can upset the whole apple cart.
I have written before a more general post about management. See: How to identify great companies to invest in – Part lll
In today’s post I will look at some of the subjective markers of top management. Let’s call it the qualitative side of investing rather than the quantitative.
A sense of stewardship
Katherine Graham’s father had bought the Washington Post newspaper at an auction in 1933. After the death of her husband, she became controlling shareholder and was responsible for writing communications to shareholders. She quotes from a letter she received from Warren Buffett when he first became a shareholder of The Washington Post Company in 1972. Buffett wrote:
“I am additionally impressed by the sense of stewardship projected by your communications to fellow shareholders. They are factual, complete and interesting as you bring your established newspaper standards for integrity to the newer field of corporate reporting.” (Graham K. Personal History. 1997) p512
Buffett read into Graham’s report a ‘sense of stewardship’. Stewardship is the conducting, supervising, or managing of something; especially, the careful and responsible management of something entrusted to one’s care. There is a real ethical element to it.
Assessing management’s demonstrated ‘sense of stewardship’ is something any investor can do. For the individual investor, there is much to be learned on this score from the tone, style and language of quarterly reports, annual reports, transcripts of the calls with analysts and press releases.
Candour and courage
Intelligently read, these communications can tell us a lot. What I am particularly looking for is forthrightness and candour. Forthrightness means not putting a gloss on things to convey how wonderful management is. Forthrightness means telling it like it is. Management that hides behind adjusted figures are suspect. Some adjusted figures are useful. Many are used to mislead. Management that glosses over the inevitable negatives in some quarterly figures are suspect. Management that acknowledges the periodic weak numbers and accepts responsibility is being straightforward with shareholders. Constantly saying that last year’s quarter made it a hard comp to beat is explaining too many things away.
One can also read these sources for insights into the entrepreneurial bent of management, leadership qualities, conservative approach to accounting, long term view, vision, strategy and administrative qualities.
Entrepreneurial spirit
In truth, management must be able to deal with periodic failures of initiatives within the business. It is said, ‘nothing ventured, nothing gained’. Management lacking an entrepreneurial spirit will not have the candour to discuss failures openly in reports to shareholders.
Leadership qualities
The leadership qualities of the CEO are told by little things like highlighting the successes of the team and not just the CEO. This sort of thing tells a lot. Even the photos used can be illuminating. You can hope to develop a sense of the culture within the company lead by the CEO. Is is one of every man for himself or is it one of collegiality?
With practice it becomes quite easy to read between the lines. A certain level of boosterism is inevitable. One quickly becomes suspicious when this goes too far.
Love the business or love money
During the 1998 Berkshire Hathaway Annual Meeting, Warren Buffett offered some insights into what he is looking for as to the primary motivation of the managers of companies they acquire.
“And we have to decide in that time when we meet them whether they love the business or love money. And we’re not making a moral judgment. Charlie may, but I’m not making a moral judgment about whether it’s better to love the business or love money, but it’s very important for me to know which of the two is the primary motivator with them.”
“I can’t tell you exactly how we — what filter it is that we put them through mentally, but I can tell you that if you’ve been around a while, you can — I think you can have a pretty high batting average in coming to those conclusions. As you can about other aspects of human behavior.”
“I’m not saying you can take a hundred people and take a look at them and analyze their personalities or anything of the sort. But I think when you see the extreme cases, the ones that are going to cause you nothing but trouble, or the ones that are going to bring you nothing but joy, I think you can identify those pretty well.”
These quotes from the 1998 AGM came to me through Acquirers Multiple blog.
Human intuition is pretty shrewd. You can read a few paragraphs in shareholder communications from the CEO and as Buffett puts it ‘I think you can identify those pretty well.”
This love money or love the company thing is a particularly subtle indicator. It is one thing to favour companies where the CEO has tens or hundreds of millions of dollars or even billions of their personal net worth tied up in company stock. Very often this is a really good sign. But sometimes a founder treats public shareholders as willing dupes to monetize the founder’s shareholding. They are in it for the money. Its different when the founder loves the company and wants to see the business pass through a succession and thrive.
Resistance to the institutional imperative
Management must have the courage to resist what Buffett calls the institutional imperative. This is the lemming like tendency of management to imitate their peers in other companies. According to Buffett the institutional imperative exists when an institution resists change, when corporate projects materialize to soak up available funds, when the leader’s cravings, however foolish, are supported by rate-of-return and strategic studies created by his troops, when expansion, acquisitions and executive compensation mindlessly imitate peer companies.
Conclusion
In short, what we are looking for is management that unfailingly thinks and behaves like an owner of the business and has the courage and candor to discuss failures openly and forthright in communicating with shareholders. Communications can convey a sense of the culture of the company and the CEO’s leadership qualities. And through it all a sense of whether the CEO is in it solely for the money or for love of a wonderful business and as a steward for all the shareholders.
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One issue that generates strong views on both sides is dual-class shares. For readers who want to dig into this, check out my post: Dual-class shares –good or bad for investors?
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