Capital Management

Nigel Littlewood and I have been reading The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. It’s a great book that analyses some true superstar CEOs that have delivered exceptional performance for shareholders. During their tenure - with the shortest being 19 years and the longest 46 years (Warren Buffett), the companies they managed delivered an average annual return of 21.6% v the S&P500 10.2%. That’s double the return of the stock market and the long term compounding effects truly eye-popping: for every 10 years on a pre-tax basis, the additional performance is a factor of 2.7 times. 

The CEOs had a number of things in common. Most notably is their unequivocally disciplined approach to capital management. They aren’t necessarily great at product, process or people management. But they are outstanding at capital management. Deploying capital to the project with the best (risk adjusted) ROE is the common mantra and don’t let money burn a hole in their pocket. If they can’t find a good investment when they have spare cash, they either let it sit in the bank or return it to shareholders. Consider that Warren Buffett (Berkshire Hathaway) sits on tens of billions of dollars of cash and Henry Singleton (Teledyne) ultimately bought back ~90% of Teledyne stock when the price occasionally traded at cheap levels.

Investing Nirvana occurs when you find such a CEO and you can buy the stock at a reasonable valuation. My colleagues and I often wonder about our tendency to buy cheap stocks run by crappy management. Even if the outcome is profitable, the experience is unpleasant. It would be far more profitable and pleasant to find outstanding management and back them with your cash.

In particular, it is our experience that companies undertaking buy-backs in decent volume when prices appear to cheap is often a beacon pointing toward management who aren’t trying to take over the world, but deploying shareholder capital judiciously. Famed short-seller Jim Chanos apparently somewhat disagrees with this view. Mr Chanos takes the view management is signalling they think they can more money in the stock market than by investing in real assets. We don’t really understand this view: if a company is trading below intrinsic value or NTA, then (all-things-being-equal) stock buy-backs make sense.

In the next blog we will discuss a company that is buying-back stock in reasonable volume that we believe is run by first-class management with a sensible and conservative approach to capital management.

Kristian