When it comes to long-term investing, how much can management and culture matter? A whole lot! Management can ruin a company or create and sustain a great one. Management and culture, along with operating and financial processes, are key components to generating superior shareholder returns. These factors can’t guarantee superior performance every time, of course. But on the whole, great companies consistently do better than not-so-great companies.
On the flip side, unless you’ve just woken up from a 50-year sleep, you have heard what bad management can do: terrible stories of mismanagement, fraud and insider trading. (Unfortunately, we are all aware of infamously poor managers and their behavior at companies such as Enron, Tyco and WorldCom.)
Putting aside dirty management, let’s talk about good and great management – cultures and operating strategies that can make a big difference in shareholder returns.
Some companies have great operating methods, strong financial controls, and a heavy focus on shareholder returns and earnings consistency. Think of the culture, operating approach and management talent at companies like Google (GOOG) , Goldman Sachs (GS), Wal-Mart (WMT), Flowers Foods (FLO), Nike (NKE), Emerson Electric (EMR) or Oshkosh Corp (OSK), to name a small sampling.
There are a number of outstanding companies that generate above-average performance (and thus command a premium to their peers). It does make a difference! In fact, you can be a well-run company in a poor industry and still find a way to do well. But it’s a lot more difficult to be a poorly run company with poor controls in an attractive industry.
Let’s look at a few companies to further clarify the importance of strong leadership:
Example #1: Illinois Tool Works – Great Success
Illinois Tool Works (ITW, Financial) is one of my all-time favorite companies. It is a large ($13 billion in revenues), relatively unknown, diversified conglomerate with great long-term results that consistently ranks as one of Forbes’ Most Admired Companies. ITW’s long-term results and stock performance are outstanding, despite being exposed to economically sensitive areas of the economy. Management is top notch, with a relentless focus on generating cash, maintaining a strong balance sheet, and creating shareholder value.
ITW’s model is truly unique. ITW is decentralized into 850 businesses and makes 20-50 acquisitions a year (typically very small, averaging $30 million each). That’s right – over 850 businesses that are independently run. The reasons behind ITW’s success are 1) its decentralization; 2) its focus on innovation and customer satisfaction; and 3) a core operating strategy called 80/20.
80/20 is simple to understand, but difficult to practice. In a nutshell, the company’s managers of these business units constantly seek to simplify their businesses – focusing on the 20% of the business that generates 80% of the profits – by pruning and isolating the good portion (20%) from the not-so-attractive (80%) portion. This focus continuously improves operating results over time. Management will keep dissecting businesses and acquisitions into smaller business units and reinstitute the 80/20 process again and again in search of gains. This unique strategy has been incredibly successful, and has produced operating margins significantly higher than most of ITW’s industrial peers.
In result, ITW almost always trades at a premium to its peers in terms of market valuation, and has consistently outperformed the S&P 500 by a very wide margin. This becomes clear when comparing the stock’s long-term performance with that of the market or almost any other (industrial) conglomerate. In ITW’s case, quality management, a highly successful operating strategy, and consistent performance do not come cheap... but the investment has been worth it for shareholders.
Example #2: Ford (F, Financial) Versus General Motors
When you think about bad industries, the automotive industry must come to mind. Despite its place in American culture, auto companies have a tough time making a profit. Management and culture can only go so far in an unattractive industry. But over the past few years, there has been a noticeable difference between Ford (F) and General Motors.
General Motors has gone into bankruptcy – and is essentially owned by the American government – while Ford has survived without government money. Even better, Ford’s recent results have been relatively impressive, given the depressed level of global vehicle sales.
Taking a closer look, GM, which had historically been known for hiring top-caliber personnel from the leading schools, became too insular and did not incorporate ideas, managers or values generated from outside the firm. Rick Wagoner and Fritz Henderson were the most recent GM CEOs (and long-time GM insiders) to be fired, and current Chairman Ed Whitacre (formerly CEO of AT&T) now seems intent on hiring a CEO from outside the company.
Ford, on the other hand, used to be closely run by Ford family members, with Bill Ford as the most recent chairman and CEO. But to his credit, Ford, albeit under shareholder pressure, realized a fresh perspective was needed some time ago, and hired an outsider, Alan Mulally, from the Boeing Company. So far, Mulally has done a good job steering Ford through this deep recession. (Hopefully, GM also hires someone who can bring a fresh look and new perspective to an outdated and lethargic corporate culture.)
Example #3: GE – Known for Producing Outstanding Talent
Some companies are known for producing great leaders and managers. General Electric’s culture, operating approach, and ability to develop outstanding managers are all well documented. GE’s systems, financial controls and execution are very well respected.
In addition, outside demand for GE executives is always high. Other companies appreciate the rigorous, fast-paced culture GE’s executives are steeped in, along with GE’s deep focus on leadership “training and development.” (According to Workforce Management, GE’s CEO Jeffrey Immelt spends 30% of his time on leadership development!)
Thus, many GE executives leave to be the CEOs of notable companies such as Home Depot (Bob Nardelli), Stanley Works (John Trani), Boeing (Jim McNerny), Chrysler (Bob Nardelli) and Nielsen (Dave Calhoun). And, as expected, when a presumable top-notch manager takes the helm of a new company, the stock price rises, and company performance typically improves.
(To be fair, in a few cases, there has been mixed success of former GE executives running new companies. And GE management, like everyone else, took its eye off the ball regarding GE’s lending and finance arm. But overall, General Electric is still seen as a model of excellence in most business categories.)
Take Advantage of All the Information
Most regular individual investors do not have the access to management that institutional investors have, so it takes extra effort to get a feel for the quality of management. But there is so much information readily available these days that, with enough digging, most everyone can get a pretty good sense of the leadership behind the stock price.
It takes time to scour through and filter all the information about a company or industry that could be relevant to management (or any number of other key topics), but for me, that’s actually the fun part of investing. As an individual investor, if you do spend time looking at annual reports – or even visiting stores and plants or listening to management interviews – I’m sure you will have a leg up on most other individual investors. You will have a better chance of making better investment decisions, and have a much better understanding of the people and culture behind the stock.
Great Returns and Great Times,
Kent Lucas
Taipan's Safe Haven Investor
http://www.thetaipanpublishinggroup.com
On the flip side, unless you’ve just woken up from a 50-year sleep, you have heard what bad management can do: terrible stories of mismanagement, fraud and insider trading. (Unfortunately, we are all aware of infamously poor managers and their behavior at companies such as Enron, Tyco and WorldCom.)
Putting aside dirty management, let’s talk about good and great management – cultures and operating strategies that can make a big difference in shareholder returns.
Some companies have great operating methods, strong financial controls, and a heavy focus on shareholder returns and earnings consistency. Think of the culture, operating approach and management talent at companies like Google (GOOG) , Goldman Sachs (GS), Wal-Mart (WMT), Flowers Foods (FLO), Nike (NKE), Emerson Electric (EMR) or Oshkosh Corp (OSK), to name a small sampling.
There are a number of outstanding companies that generate above-average performance (and thus command a premium to their peers). It does make a difference! In fact, you can be a well-run company in a poor industry and still find a way to do well. But it’s a lot more difficult to be a poorly run company with poor controls in an attractive industry.
Let’s look at a few companies to further clarify the importance of strong leadership:
Example #1: Illinois Tool Works – Great Success
Illinois Tool Works (ITW, Financial) is one of my all-time favorite companies. It is a large ($13 billion in revenues), relatively unknown, diversified conglomerate with great long-term results that consistently ranks as one of Forbes’ Most Admired Companies. ITW’s long-term results and stock performance are outstanding, despite being exposed to economically sensitive areas of the economy. Management is top notch, with a relentless focus on generating cash, maintaining a strong balance sheet, and creating shareholder value.
ITW’s model is truly unique. ITW is decentralized into 850 businesses and makes 20-50 acquisitions a year (typically very small, averaging $30 million each). That’s right – over 850 businesses that are independently run. The reasons behind ITW’s success are 1) its decentralization; 2) its focus on innovation and customer satisfaction; and 3) a core operating strategy called 80/20.
80/20 is simple to understand, but difficult to practice. In a nutshell, the company’s managers of these business units constantly seek to simplify their businesses – focusing on the 20% of the business that generates 80% of the profits – by pruning and isolating the good portion (20%) from the not-so-attractive (80%) portion. This focus continuously improves operating results over time. Management will keep dissecting businesses and acquisitions into smaller business units and reinstitute the 80/20 process again and again in search of gains. This unique strategy has been incredibly successful, and has produced operating margins significantly higher than most of ITW’s industrial peers.
In result, ITW almost always trades at a premium to its peers in terms of market valuation, and has consistently outperformed the S&P 500 by a very wide margin. This becomes clear when comparing the stock’s long-term performance with that of the market or almost any other (industrial) conglomerate. In ITW’s case, quality management, a highly successful operating strategy, and consistent performance do not come cheap... but the investment has been worth it for shareholders.
Example #2: Ford (F, Financial) Versus General Motors
When you think about bad industries, the automotive industry must come to mind. Despite its place in American culture, auto companies have a tough time making a profit. Management and culture can only go so far in an unattractive industry. But over the past few years, there has been a noticeable difference between Ford (F) and General Motors.
General Motors has gone into bankruptcy – and is essentially owned by the American government – while Ford has survived without government money. Even better, Ford’s recent results have been relatively impressive, given the depressed level of global vehicle sales.
Taking a closer look, GM, which had historically been known for hiring top-caliber personnel from the leading schools, became too insular and did not incorporate ideas, managers or values generated from outside the firm. Rick Wagoner and Fritz Henderson were the most recent GM CEOs (and long-time GM insiders) to be fired, and current Chairman Ed Whitacre (formerly CEO of AT&T) now seems intent on hiring a CEO from outside the company.
Ford, on the other hand, used to be closely run by Ford family members, with Bill Ford as the most recent chairman and CEO. But to his credit, Ford, albeit under shareholder pressure, realized a fresh perspective was needed some time ago, and hired an outsider, Alan Mulally, from the Boeing Company. So far, Mulally has done a good job steering Ford through this deep recession. (Hopefully, GM also hires someone who can bring a fresh look and new perspective to an outdated and lethargic corporate culture.)
Example #3: GE – Known for Producing Outstanding Talent
Some companies are known for producing great leaders and managers. General Electric’s culture, operating approach, and ability to develop outstanding managers are all well documented. GE’s systems, financial controls and execution are very well respected.
In addition, outside demand for GE executives is always high. Other companies appreciate the rigorous, fast-paced culture GE’s executives are steeped in, along with GE’s deep focus on leadership “training and development.” (According to Workforce Management, GE’s CEO Jeffrey Immelt spends 30% of his time on leadership development!)
Thus, many GE executives leave to be the CEOs of notable companies such as Home Depot (Bob Nardelli), Stanley Works (John Trani), Boeing (Jim McNerny), Chrysler (Bob Nardelli) and Nielsen (Dave Calhoun). And, as expected, when a presumable top-notch manager takes the helm of a new company, the stock price rises, and company performance typically improves.
(To be fair, in a few cases, there has been mixed success of former GE executives running new companies. And GE management, like everyone else, took its eye off the ball regarding GE’s lending and finance arm. But overall, General Electric is still seen as a model of excellence in most business categories.)
Take Advantage of All the Information
Most regular individual investors do not have the access to management that institutional investors have, so it takes extra effort to get a feel for the quality of management. But there is so much information readily available these days that, with enough digging, most everyone can get a pretty good sense of the leadership behind the stock price.
It takes time to scour through and filter all the information about a company or industry that could be relevant to management (or any number of other key topics), but for me, that’s actually the fun part of investing. As an individual investor, if you do spend time looking at annual reports – or even visiting stores and plants or listening to management interviews – I’m sure you will have a leg up on most other individual investors. You will have a better chance of making better investment decisions, and have a much better understanding of the people and culture behind the stock.
Great Returns and Great Times,
Kent Lucas
Taipan's Safe Haven Investor
http://www.thetaipanpublishinggroup.com
