In 1955, Senator Estes Kefauver of Tennessee was considering running for president. After a particularly warm reception at an event in New York City, he turned to his campaign strategist and remarked how much support he had in the room. His aide – a laconic, tall, bald, and battle hardened warrior said, “People with the biggest smiles are usually the first to cut you out. Remember Jesus was betrayed with a kiss. Never, ever mistake friendly with supportive.”
We bring this story up because you often hear about finding investments with shareholder friendly management. At Nintai, we certainly count ourselves in the camp searching for companies meeting that criteria. However, we think it would be wise to follow our political aide’s advice that investor friendly management isn’t always supportive of investors.
Before we get into that discussion, a definition of shareholder friendly might be helpful. For some, shareholder friendly management is a team that produces a steady increase in share price. In 1999 alone, Jack Welch, former CEO of General Electric had the phrase "shareholder friendly" matched to his name over 1.4 million times[1]. We can't say we agree with this definition. We think individuals are putting the cart before the horse when they link share price to shareholder friendliness - or for those of Wall Street lexicon - shareholder value. Nintai believes there are certain attributes that when implemented and made part of the corporate DNA will eventually drive share price. The operative word here is “eventually”. Actions taken to drive share price alone are not shareholder friendly. They are options holder - generally meaning senior management - friendly. What we look for are traits that generally don't move the stock price on their own but rather by their cumulative effect. In fact, some of these qualities can actually decrease share price when Wall Street panics about the next quarterly earnings call. In search for new investment opportunities, we think there are four (4) attributes that reflect friendly and supportive corporate management.
They Act Wisely in Allocating Capital
One of the clear indicators of shareholder friendly management is wise allocation of capital. This includes funding initiatives that can produce returns in excess of the cost of capital either in the short or long term. This also includes buying back shares when company stock trades below intrinsic value. If neither case exists then it includes returning capital in the form of dividends to shareholders. These – in any combination – are real measures of a shareholder friendly management. Expeditors International (EXPD, Financial), a long time holding of the Nintai portfolio, is a great example of these values. Senior executives are encouraged to evaluate each strategic initiative through the lens of return on capital, lost opportunity costs, and a brief description why this will add value to shareholders. In the absence of long term value creation, management is committed to returning capital to shareholders through quarterly or special dividends.
They Eat Their Own Cooking
We greatly prefer managers who have a large stake (proportional to their financial situation) that was acquired in the general markets. We don’t believe senior managers who have acquired 5% of the company through stock options are the ideal shareholder friendly management. Nothing pleases us more than seeing senior managers purchasing shares on the open market as the share price drops. Fastenal (FAST, Financial) - a long time holding in the Nintai portfolio - is a great example of this. Since the stock has dropped roughly 15% since April, 2014, senior managers and Board Directors have been purchasing the stock hand over fist. Stock sales during this time have all been planned distributions. Nothing shows more commitment than these types of actions.
They Treat Corporate Money Like Shareholder Money
We admire senior executives who are as frugal in their private corporate spending as they are in utilizing capital in strategy. A great example of this is Fastenal’s recently retired CEO/Chairman Bob Kierlin. He was a fanatic about cost savings. In an interview he stated “Being careful about your expenditures, whether large or small, requires a total commitment. Either you do a good job of cost control in all aspects of your business, or you start losing it…. Frugality is an attitude you develop. Once you have it, it sticks with you in everything in life. You don't have to think about it." Inc. Magazine[2] said it best when it described Kierlin in the following manner:
“Frugality touches all aspects of his life. Kierlin, 58, eschews all small talk, speaking only when he has something to say. He drives an Oldsmobile and has taken home the same $120,000 yearly paycheck for the past decade, even though the Fastenal board has repeatedly authorized an increase for him. His office reflects his unpretentiousness: used furniture, a few photos of loved ones, and a PC, which he uses to type his own correspondence. He has no personal secretary. And then there are his suits. At a discount store, they'd probably go for $200 apiece. But Kierlin didn't buy them there. He got them from the manager of a men's clothing store. Not from the manager's store. From the manager. The suits are used. "Luckily, we're the same size," says Kierlin, a triumphant smile crossing his face. "I picked up six of those suits for 60 bucks each."
Being cheap alone doesn’t make us happy. Being cheap in the areas that matter (cost controls) and wise in allocating capital make for very shareholder friendly management. And they generally lead fantastic investment opportunities. .
Open and Frank Communications
Over our lifetime we’ve found the more someone talks about how honest they are (“I want to be utterly honest with you….”) the less they tell the truth. We greatly admire management that both tells the truth and communicates directly with investors. This includes writing their own CEO sections of an annual report, answering questions from shareholders on a regular basis such as Morningstar (MORN, Financial) and Expeditors International (EXPD, Financial) (both Nintai holdings), and clearly explaining their actions and mistakes.
Conclusions
When you hear about shareholder friendly management, we think it’s vital investors discern between those interested solely in “shareholder value” or stock appreciation and those who build a company designed to see investors as partners on the long journey to success. Being “friendly” doesn't always mean saying things shareholders want to hear. The best partners provide a dynamic, give-and-take relationship structured to survive the inevitable ups and downs of the stock market. Senator Kefauver learned not to mistake friendly for supportive when 15 of the 20 individuals at that event in 1955 voted against him at the 1956 convention. At Nintai we seek both friendly – and supportive – management in our investments. It has served us well over the years and we think it will do so for you as well.
As always, we look forward to your thoughts and comments.
[1] That is until his comments in an FT article, “Welch Denounces Corporate Obsessions”, Financial Times, March 12th, 2009. His retirement package and benefits didn’t help much either.
[2] “The Cheapest CEO in America”, Mark Ballon, Inc Magazine
