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Successful investing depends on the ability to assess managerial quality. Years ago, legendary stock picker Phil Caret advised: ‘‘Good management is rare at best, it is difficult to appraise, and it is undoubtedly the single most important factor in security analysis.’’
Last month, the distinguished investor, Prem Watsa, in his annual letter to shareholders of Fairfax Financial Holdings
FFH,
concurred: “The most important determinant of long-term success in any investment is good management, led by an outstanding CEO.”
But what makes for a good manager? While details vary, every manager and investor would benefit from this thumbnail sketch of quality managers, some culled from my book “Quality Investing.”
1. Disciplined, but nimble: Quality managers (QM) invest in organic growth and prudent acquisitive growth. But they resist the temptation of grabbing growth through big acquisitions, which often destroy shareholder value while enlarging a manager’s domain. Undisciplined acquisition sprees signal vanity, not quality. On the other hand, they have a good sense for the opportunistic, in acquisitions and otherwise.
2. Independent: QMs act according to their internal conviction, not external fashions or the latest trends. They question calls for cookie-cutter governance and, while listening to constructive criticism from activist shareholders and others, do not bend their convictions.
3. Long-term business vision while focused on the present: QMs look beyond their own tenure as CEO — years ahead, not quarters. This long-term view may manifest in service contracts, R&D projects, scientific enterprises and leases and products. For example, Diageo’s
DEO,
9,000-year lease on its Guinness Dublin brewery. All that said, QMs do not let long-term vision be an excuse for repeated short-term failure.
4. Limited publicity: Celebrity CEO status tends to benefit the CEO more than the company. Subpar corporate performance is often the result, as the economists Ulrike Malemendier and Geoffrey Tate have shown. The exception proves the rule, as celebrity CEOs with good business records tied their personal status to corporate purposes, epitomized by Ryanair Holdings’
RYAAY,
Michael O’Leary, Virgin Galactic Holdings’
SPCE,
Richard Branson and Berkshire Hathaway’s
BRK.A,
BRK.B,
Warren Buffett.
5. Promote quality employees: QMs understand that employees are a company’s most valuable resource, and are often the difference between success and failure, according to “Talent Managers” by Bill Conaty and Ram Charan. Developing and deploying talented teammates are high priorities of quality managers. Results confirm this mindset in everything from productivity rankings to employee survey data. At managerial levels, results may appear in recruiting by other companies.
6. Candid communications: QMs talk straight with both staff and shareholders. That means simple language rather than foggy elliptical prose. It means writing one’s own letters or press-release quotes rather than using the PR staff. Such candor can be detected in all communications, including at annual meetings and on quarterly calls.
7. Think like owners: Smart stockholders and savvy CEOs share a business’s top priority: effective capital allocation. QMs put themselves in the shoes of shareholders when deciding how to spend the company’s money. They prize putting every dollar to its highest use, from organic or acquired growth to share buybacks and dividends.
8. Aligned with shareholders: QMs purchase company stock with their own cash and show an intention to hold it indefinitely. (For companies that pay no- or low dividends because of their ability to redeploy capital at high after-tax rates, quality managers may periodically sell small portions of their stakes for liquidity.)
Maintaining quality is a conscious, continuous, and intelligent effort. To paraphrase the 19th century British critic, John Ruskin, or, in the blunter terms of Aristotle: “Quality is not an act; it is a habit.”
Lawrence A. Cunningham is a professor at George Washington University, longtime shareholder of Berkshire Hathaway, and publisher, since 1997, of The Essays of Warren Buffett: Lessons for Corporate America. To get updates, including an invitation to his exclusive webinar during Berkshire Hathaway’s 2021 Annual Meeting, sign up here.
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