Over the last weekend, I met friends from Engineering School days, some I had not seen for over 20 years. As copious amounts of beer was imbibed, we exchanged memories and achievements of our cohort of 1995. There were about 10 people I admired deeply from my Class of about 600 and I reflected on their journey and achievements. Most of this group of 10 seem to have done extraordinary well for themselves. There were a few surprises of course.
But the success of these 10, measured solely on career trajectory or their chosen pursuit outside mainstream business (development sector, theatre), was clearly at the top 5% of the cohort… and they seem well positioned to widen the gap with peers over time.
I would aver that what explains the significant outperformance of this sub group was the inherent “quality” of the individuals; a combination of inherent smarts, an outstanding work ethic, a personality that extended beyond pure academic pursuit and an emotional IQ to deal with tough situations.
At SOLIDARITY, the “quality of management teams” is our primary filter to evaluate companies. We look for marathon runners over sprinters, those who are building their organization for distance and, if necessary as a compromise, are prepared to sacrifice speed. We don’t shy from paying a higher price for quality when we recognize it because we know that these companies may have short term performance issues, but have a higher probability of outgrowing competition in the long haul.
Can management quality be recognized and measured? The success of the narrow group above was no surprise to most, suggesting the attributes leading to success are not hard to spot.
In the business world, subjective measures give good clues. Consider a few examples
- In the Banking space, there are very few companies who transparently report NPAs and have reporting standards for bad loans that are tighter than regulators. And there are others notorious for managing their books. Why would management run up bad loans by lending to sectors they don’t understand? And why would they massage their books and not report things as they are?
- In the Consumer space, there are teams that want to grow brands through Advertising blasts (raised through equity dilution) rather than through the product’s self-generated cash flow. What happens to the brand when it is off steroids? And what if a competitor starts steroid treatment when you are done?
- In the Pharmaceutical space, we are very skeptical of Management that have been pulled up for “data integrity” issues by the FDA. Why would you inculcate a culture that knowingly fudges a recommended process that ensures quality of a product meant to cure? Can this culture ever be changed?
It is not “family run” vs “professionally run” that is the differentiator but the underlying thought process of the leadership team at the helm.
Try a thought experiment. What if these select few individuals were “companies” that one could have “invested in” when they graduated? Would you have chosen an average graduate – obviously available cheap – for someone amongst the select group who was a star but was available at a premium? Essentially, would you have taken a bet that an individual who wasted their college years would flower as a star later in life? Probably not. While one could be lucky, the odds would favour investing in the star graduate.
However, when it comes to investing, most people pick the “cheap average graduate” in the hope of outperforming the proven star, just because the star is more expensive. As there is significant focus on near term multiples, analysts underestimate the ability of quality companies to compound earnings faster than the average company.
The overlooked insight is that the quality company which looks expensive vs the average Joe when measured on next year earnings is actually cheaper when measured five/ten years out as it would have created a significant earnings gap over time.
Quality is not ubiquitous. However, if you spend time looking, it is not hard to spot. Seize it when you spot it at a fair price, and have the patience to let the jockey do the rest