William Thorndike
Jr.'s The Outsiders considers eight Hall of Fame CEOs (and, in some
cases, the small teams that they worked closely with), the only executives that
passed his twin tests: outperforming companies in their peer group, and besting
the performance of General Electric's Jack Welch, widely considered one of the
finest managers in business history.
Thorndike found that unlike the jet-set, media-savvy,
wheeling-and-dealing, larger-than-life Welch, the truly elite eight were
modest, private, and humble. Their most
notable qualities, however, were cerebral.
As Bill Stiritz of Ralston Purina put it: "Leadership is
analysis" (145). And all of the
featured executives had the independence of mind to turn analysis into action.
Warren Buffett has
noted that most CEOs, however exemplary their abilities in areas such as
marketing, production or administration, tend to be poor capital
allocators. They're executors, not
investors. However, decisions about what
to do with a spare dollar are just as important to the long-term performance of
a business as the day-to-day operations.
In terms of specific policies, most of the featured CEOs repurchased
shares, but none paid a significant dividend; all focused on one version or
another of cash flows, rather than emphasizing earnings; and none provided earnings
guidance to analysts - in short, they behaved like investors, rather than
operators. They didn't out-manage Welch;
they bested him in the area of capital allocation.
Perhaps Thorndike's
greatest achievement in the book is to resurrect the largely forgotten story of
Henry Singleton, who Warren Buffett regards as among the greatest capital
allocators in the history of business.
No business major, Singleton earned a PhD in electrical engineering, was
awarded the Putnam Medal as the best math student in America, and played chess
at an almost-grandmaster level. In 1960,
he and a partner founded a small firm, Teledyne, a conglomerate that swallowed
a mind-boggling 130 companies in its first decade of existence, using his own
firm's high-priced stock as the currency.
While the sheer scale of his shopping spree might suggest an indiscriminate
approach to acquisitions, Singleton was in fact a bargain-hunter: he never paid
more than 12x earnings.
Singleton
understood that using Teledyne's stock to fund acquisitions made sense only if
that stock was fully (or over) priced, and by 1971 he had grown the share count
by about 14x. However, when the
conglomerate form fell out of favor on Wall Street, Teledyne's stock swooned,
and he correctly reversed course. Not only
did he never again issue a single share of additional stock, he spent the next
decade-plus retiring an unheard of 90% of Teledyne's shares. In part by issuing stock at an average P/E of
25, and buying it at an average of 8, Singleton managed to grow EPS by a
world-beating 27% per year for 33 years.
Just as he had
earlier retreated by repurchasing shares that had been previously issued,
Singleton eventually decided to dismantle the conglomerate that he'd spent his
life building. He spun out several of
Teledyne's largest operating companies, and sold what remained to another firm,
but only at a full price. What was it
all for? A 20.4% stock return over
nearly three decades, or an 180-to-1 increase.
John Malone, who
has made his eye-popping fortune in the cable and media industries, allocates
capital, and leaves operations to a trusted number two, as well as local
managers. For many years as he built his
empire, Malone was the only significant cable company CEO to strive for cash
flow growth, rather than increases in EPS.
In fact, the now widely used acronym EBITDA was coined by Malone. (Admittedly, this is not a wholly desirable
accomplishment). Recognizing that scale
is a powerful competitive advantage for cable operators, Malone bought smaller
competitors at a heated pace, but managed to do so on attractive economic
terms. Not only did size lead to lower
costs - and higher cash flows - per subscriber, Malone used it to strike unique
deals in which he acquired stakes in up-and-comers such as BET and Discovery in
return for access to his imposing subscriber base. Thorndike argues convincingly that Malone
used joint ventures more often and more effectively than any other CEO ever
has, perhaps adding a sixth category to the Big Five types of capital
allocation. The scorecard: 30.3% per
year from 1973 to 1998, over 900-to-1.
Inevitably, a book
about capital-allocating CEOs will include a chapter on Warren Buffett and Charlie
Munger. While the chapter itself covers
no new ground, it's an able summary of the twin Oracles of Omaha, and offers a
nearly up-to-date performance record: 20.9% over 45 years, or a 6,265-to-1
return. But Buffett and Munger cannot be
bound and contained in a single chapter.
In fact, the book reads a little like an experimental, post-modern
literary work, in which the mischievous author (Buffett) writes a book wherein
its main character (Thorndike) writes a book about the author (Buffett). After all, Thorndike, like most investors,
almost certainly first heard of Tom Murphy and Dan Burke of Capital Cities and Henry
Singleton from Buffett; Kay Graham would not have fared nearly as well as she
did without the active, ongoing counsel of Buffett, long the Washington Post's
largest shareholder; Buffett invested in General Dynamics well before it became
a must-read case study; and most of the books Thorndike cites are about, or
have been recommended by, Buffett and Munger.
Though Buffett,
Munger and Singleton are three of the finest, most original minds in the
history of business and investing, better capital allocation is possible for
most CEOs, regardless of their ability to play chess blindfolded or perform
complex calculations in their head. In
fact, the book left this reader frustrated: a few of the case studies offer
formulas that are so simple they border on boring. How difficult can it be, after all, to close
or sell poor businesses? To be sure, not
all businesses can be above average, but shareholders as a whole would be
meaningfully richer even if CEOs were better at just one simple task:
discriminating between paying a dividend and repurchasing cheap shares. For even a moderately disciplined chief
executive, buybacks are a far more attractive option over the long-term, since
most stocks are undervalued in the market from time to time. Thorndike is more optimistic than this reader
about the potential uses of leverage: even the uber-talented John Malone nearly
succumbed to bankruptcy - largely because of debt that he inherited, but not
entirely - and few CEOs will be mistaken for Malone.
Rather than merely
reassembling and reinterpreting publically available material, Thorndike
conducted nearly 100 interviews, talks that included many of the (surviving)
subjects themselves, as well as people who worked directly with them, adding
freshness to the book. In addition to
the stories noted above, he offers analysis of the Dick Smith at General
Cinema, and Bill Stiritz at Ralston Purina, case studies unknown even in many
business schools. And for active investors,
Thorndike addresses a few potential investments, including Transdigm, Sara Lee,
Exxon Mobil and the collection of companies controlled by John Malone. This fine book ought to be read by most
investors; but it's an emphatic must read for all CEOs.
Source: Thorndike, Jr.,
William. The Outsiders: Eight
Unconventional CEOs and Their Radically Rational Blueprint for Success.
Boston: Harvard Business Review Press, 2012.
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