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Thomas Macpherson
Thomas Macpherson
Articles (119)  | Author's Website |

Investor Friendly Management

May 08, 2015 | About:

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 (NASDAQ:EXPD), 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 (NASDAQ:FAST) - 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 (NASDAQ:MORN) and Expeditors International (NASDAQ:EXPD) (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

About the author:

Thomas Macpherson
Thomas Macpherson is a portfolio manager at Dorfman Value Investments. The views expressed in his articles are his own and not necessarily those of the firm. He is the author of “Seeking Wisdom: Thoughts on Value Investing.”

Visit Thomas Macpherson's Website


Rating: 4.9/5 (8 votes)

Voters:

Comments

jsal56
Jsal56 - 3 years ago    Report SPAM

Excellent article again Thomas, thank you for writing.

Thomas Macpherson
Thomas Macpherson premium member - 3 years ago

Hi Jsal. Thank you very much for your comment. I'm glad you enjoyed the article. Best - Tom

Robert Abbott
Robert Abbott premium member - 3 years ago

Thanks for an insightful article, Tom! How would you suggest that we retail investors assess the frugality of executives? Bob Abbott

The Science of Hitting
The Science of Hitting - 3 years ago    Report SPAM

Great article Tom, as always.

ramos285
Ramos285 premium member - 3 years ago

Hi Thomas. Excellent again.

Thomas Macpherson
Thomas Macpherson premium member - 3 years ago

Hi Bob: I think a great place to start is the Annual Report. We always start by reading the Management Notes section first. We think you can tell a lot from this section in regards to how they see compensation, issues, mistakes, etc. More importantly, unfriendly management has a tendency to hide unseemly news in this section as they assume no one will take the time to read it. Finally, we always call and ask for the CEO. A couple of times CEOs have actually answered the phone - and that's a big plus for us. One of our company's CEO has taken our call every year since 2008 and we chat about the business and outlook. He wouldn't want me to call every week, but he's happy to talk to a long term shareholder. Give it a try. Just some thoughts. Thanks for the comment. Best. - Tom

Thomas Macpherson
Thomas Macpherson premium member - 3 years ago

Thanks Science. Much appreciated. Best - Tom

tonybuffett
Tonybuffett - 3 years ago    Report SPAM

Great article! One of my favorite lines was "We greatly prefer managers who have a large stake (proportional to their financial situation)" The words in the bracket resonated in me becuase I can never forget that extra bit. If a CEO owns 2% of his company that may seem small but if it's 85% of his wealth then that can make all the difference.

What are your views of Boards requiring their executives to hold X amount of shares by some date.?

Thomas Macpherson
Thomas Macpherson premium member - 3 years ago

Hi Antonio. Thanks for your comment. Glad you enjoyed the article. Best. - Tom

Thomas Macpherson
Thomas Macpherson premium member - 3 years ago

Tony. Thanks for your comment. We've been cognizant of the proportional issue since watching a classmate have to take a loan from his partners on joining his firm. At the time it represented every penny he owned. We really don't have a view on requiring executives to own a certain percentage. I guess our thought has been if you need to tell an executive to be an owner you probably picked the wrong person. What are your thoughts? Thanks again. Best. - Tom

perots
Perots - 3 years ago    Report SPAM

Do you have a link to your portfolio and letters?

Thomas Macpherson
Thomas Macpherson premium member - 3 years ago

Hi Perots. We have stopped posting our portfolio holdings after Q115 but you can see where we stood at the end of 2014 with our article "2014 Year in Review". We don't publish our investor letters. Feel free to peruse our other articles here on GuruFocus however. Thanks. - Tom

The Science of Hitting
The Science of Hitting - 3 years ago    Report SPAM

Just to add to Tom's response from Bob's question, another great place to look is shareholder letters. As an example, take BNY Mellon's 2009 shareholder letter: the (former) CEO spent as much time discussing employee donations to Haiti (~$900,000) as he did on the $1.6 billion in securities write-downs the company took in the prior year under his leadership. In my experience, little things like that are worth remembering. A period like 2008 / 2009 gives you an opportunity to see how current CEO's reacted to hardship; important to this discussion, it also provides an opportunity to see how they communicated with the owners of the business.

Hope that's helpful!

snowballbuilder
Snowballbuilder - 3 years ago    Report SPAM

Tom great article and central topic as usual . I ve take the suggestion of your article to review the management of all my (7) Holdings.

The CEO of my biggest holding is a member of the founding family.

His family still have the bulk of his wealth invested in the company,

they are cautious and with a long term view

They have built the company with organic growth and succesfull bolt on acquisition .

They have Made only strategic acquisition , they dont overpay and they dont issue stock. They pay cash.

They dont buy just to growth, they are focused on margin and free cash flow

They are rational , effective and oriented to all the shareholders.

They pay 50% of the EPS in dividend and have Made some buyback when the market was down.

I m invested with them since 2009, i m making a lot of money (BOTH from dividend and capital apprecciation) and i sleep really well.

Tom ad usual thanks for a great article and for have Made me thoughts. Best Snow.

tonybuffett
Tonybuffett - 3 years ago    Report SPAM

Hi again Tom, thanks for your response and I hope you're enjoying your Monday with a form 10-K and margarita ;) I liked this line you wrote "If you need to tell an executive to be an ower you probably picked the wrong person". I totally agree with this point. I had never heard of companies requiring their executives to own a portion of the company untill I read the the Rocky Mountain Dealerships (RME.TSX) proxy statement. I guess its the hope of Boards to try to align the interests of management with stockholders. Stock options don't perfectly align shareholder interest and mangements together since shareholders put up their own capital and bear all the risks, where as management is given options for "free" without having to stake their own capital. So I guess the "best" next solution was this "make your executives put up their own capital". But I totally agree that you shouldn't be forced to eat your own cooking. You should want it becuase its good!

Tony

PS: What are your recomendation for books? I've got all the classics. Ben Graham, The Letters of Warren B, Phil Fisher. I'm currently reading up on Porters' Five Forces and Value Chain.

Thomas Macpherson
Thomas Macpherson premium member - 3 years ago

Hi Snow. Thank you very much for your kind words. I'm glad we are learning together! Tony - I wrote an article about a month ago entitled "Investment Reading". It can be found here (http://www.gurufocus.com/news/326406). Hope this helps. My best wishes. - Tom

tonybuffett
Tonybuffett - 3 years ago    Report SPAM

Hi again, I was just reading this years Amazon shareholder letter and thought of you when I read the opening line:

To our shareowners:

A dreamy business offering has at least four characteristics. Customers love it, it can grow to very large size, it has strong returns on capital, and it’s durable in time – with the potential to endure for decades. When you find one of these, don’t just swipe right, get married.

I feel like Jeffs been hanging around Buffett! :P There's alot in that short but amazingly distillled paragraph but I think it sums up perfectly what all of us are lookuing for.

Happy investing

Tony

Thomas Macpherson
Thomas Macpherson premium member - 3 years ago

Thanks Tony for your comment. Hope you are having a happy and safe holiday weekend. Best. - Tom

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