Column

Summary of the Book: Outsiders

The_Outsiders_William_N_Thorndike_Book

By Enrique Aboitiz Mendieta

09 2017

Now let’s remember these books and pieces of advice need to be taken in context. They are in the U.S. atmosphere. We are in the ROCC ( Republic of the Choo Choo train), so not all applies. Now, some apply everywhere like the importance of cash flow.


Unconventional CEOs and their radically rational blueprint for success

“You are what your record says you are.” – Bill Parcels

IT IS WHAT GETS DONE THAT MATTERS – NOTHING ELSE!

“Success leaves traces.” – John Templeton

Jack Welsch – 20.9% compounded annual return for GE Shareholders. The greatest CEO of the last 50 years? NO!!!

What matters is relative return not absolute return. The context of the atmosphere, interest rates and so forth, have to be taken into account. If interest rates are at 2%, the rest are making 6 and you are making a return of 12%, then you are doing better than if you make 20% in an interest environment of 18% and everyone is making 24% as an average. Long-term return to your peers is what matters.

A gold mine will not make the same profits when gold is at USD 1900 or when it is at USD 400 an ounce, no matter which leader is in place.

The period of time matters.

CEOs need to do two things well:

  1. Run the operations efficiently
  1. Deploy the cash generated by those operations

Five Choices for deploying capital:

  1. Investing in existing operations
  1. Acquiring other businesses
  1. Issuing dividends
  1. Paying down debt
  1. Repurchasing stock

Three Alternatives for raising capital:

  1. Internal cash flow
  1. Issuing debt
  1. Raising equity

Warren Buffett: Most CEOs are not skilled in capital allocation. Their inadequacy is not suprising. They rise to the top because they have excelled in marketing, production, et. al. Now they must make capital allocation decisions.

Singletonville :

  1. Capital allocation is the CEO’s most important job
  1. What counts in the long run is the increase share value, not overall growth or size.
  1. Cash flow, not reported earnings, is what determines long-term value.
  1. Decentralised organisations release entrepreneurial energy and keep both costs and “rancor” down.
  1. Independent thinking is essential to long-term success, and interactions with outside advisers. (Wall Street and the press can be distracting and time consuming)
  1. Sometimes, the best investment opportunity is your own stock.
  1. With acquisitions, patience is a virtue…as is occasional boldness.

“It is impossible to produce superior performance unless you saw something different.” – John Templeton

Don’t be a blind contrarian, be an intelligent iconoclast – informed by careful analysis and often expressed in unusual financial metrics that were distinctly different from industry or Wall Street.

Warren Buffett: Institutional imperative is a mysterious force, the equivalent of teenage peer pressure, that impelled CEOs to imitate the action of their peers – ubiquitous warning that effective CEOs needed to find someway to tune out.

As a group they were very greedy when others were fearful, deeply independent, generally avoiding communication with Wall Street, disdaining the use of advisers, and preferring decentralized organizational structure that self-selected for other independent thinkers.

Focus on cash flow and not earnings for Wall Street. Net income is a blunt instrument and can be distorted by differences in debt levels, taxes, capex and past acquisition history.

I. Tom Murphy & Capital Cities Broadcasting

  • Two resources – financial and human – the emphasis on the latter concerns flat and dehydrated corporate staffs.
  • Extraordinary autonomy for operating managers. Decentralisation is the cornerstone of the philosophy. Hire the best people and give them the responsibility and authority to decide at the local level. Expectation – be costs conscious and exploit sales potential.
  • Budget sessions were not perfunctory. They produced something material. Cut your way to high margins.
  • Hiring – clear preference for intelligence and ability. Talent and fresh ideas looked for. Comfort in giving promising young people responsibility.
  • Use the assets that are paid for and generating cash to leverage the purchase of new assets. Never use investment banker.
  • Benchmark – double digit returns over ten years without leverage.

II. Henry Singleton & Teledyne

“I change my mind when the facts change. What do you do?” -J.M. Keynes.

  • Extreme decentralization – breaking the company down into its smallest component parts and driving accountability and managerial responsibility as far down as possible.
  • Cash generation is emphasized.
  • Stock repurchases are a more tax efficient form of returning capital to shareholders than dividends.
  • Strategic plan – My plan is to keep coming to work. I like to steer the boat everyday rather than plan ahead way into the future.
  • If everyone’s doing them, there must be something wrong with them.

Buffett and Singleton saw themselves as investors, not managers – capital allocation, not operations. Primarily invest in what you know and are comfortable with. No quarterly guidance given. Did not pay dividends. Significant CEO ownership. Used float.

III. Bill Anders & General Dynamics

“A foolish consistency is the hobgoblin of little minds.” – R.W. Emerson

Three tenets:

  1. Number 1 or 2 position
  1. Exit commodity businesses
  1. Stick to what you know well.
  • Cash flow.
  • Best capital allocators are practical, opportunistic and flexible.

IV. John Malone & TCI

“Luck is the residue of design.” – B. Rickey

  • Shelter cash flows from taxes.
  • There is an apparent inverse relationship between the construction of elaborate new headquarter buildings and investor returns.
  • Only purchased companies if the price paid translated to a maximum of 5 times cash flow.
  • Quality of assumptions matters.
  • Strong culture and great employee loyalty.

V. Bill Stiritz & Ralston Purina

“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.” – W. Buffett

  • High margin and low capital requirements.
  • Effective capital allocation requires a certain temperament. You need to think like an investor dispassionately and probabilistically, with a certain coolness.
  • Sought for undermanaged companies that their management team could improve with their marketing and distribution clout for example.

The sale of CitySavings to UnionBank is an example of taking an under-managed, not badly managed, but under-managed or under-maximized company and taking it newer heights through UnionBank, because UnionBank had a lower cost of capital, great access to funds and a deeper bench.

  • JEALOUSY GUARDED HIS TIME ESCHEWING HIGH VISIBILITY, TIME CONSUMING PHILANTROPIC BOARDS AND AVOIDING CASUAL LUNCHES AS MOSTLY A WASTE OF TIME…other boards were an opportunity to get exposed to new situations and ideas. Avoid time consuming interaction with Wall Street.
  • Fox-like sponge for new thinking regardless of its origin – some people are innovators and some borrow from others.
  • Carved out time to wrestle with key issues in the business alone without distraction.

BUFFETT – he has 5 hours a day free to read and think.

VI. Dick Smith & General Cinema

“It’s remarkable how much value can be created by a small group of really talented people.” – D. Wargo

  • Capital allocation – cash flow was in advance. Strategic debt. Minimize tax.
  • Rare for CEOs to sell a business without outside pressure!

VII. Warren Buffett & Berkshire Hathaway

“You shape your houses and then your houses shape you.” – W. Churchill

“The most powerful force in the universe is compound interest.” – A. Einstein

  • Attracted to Berkshire Hathaway – cheap price relative to book value.
  • Invested in consumer brands with “franchises.”
  • See’s bought for USD25 million – USD1.65 million in free cash to Omaha over 39 years.
  • Generated funds at 3% and invested them at 13 % – secret to their long-term success – insurance float.
  • BUYS AND TAKES IMMEDIATE CONTROL OF THE CASH FLOW -EXCESS CASH TO OMAHA.
  • Operations highly decentralized – cash highly centralised.
  • Most CEOs are limited by prior experience to investment opportunities within their own industries.
  • Capital allocation – Never paid a dividend or repurchased significant amounts of stock. He invested or bought in publicly listed or private companies.

Two distinguishing characteristics in Warren Buffett’s investing style: high degree of concentration and extremely long holding periods.

HE HAS CREATED AN ATTRACTIVE, HIGHLY DIFFERENTIATED OPTION FOR SELLERS OF LARGE PRIVATE BUSINESSES – ONE THAT FALLS SOMEWHERE BETWEEN AND IPO AND A PRIVATE EQUITY SALE… the owner can sell and still run the business, achieve liquidity and still run the business without interference.

  • Never participates in auctions.
  • Never spends time with analysts
  • Never attends investor conferences.
  • Communicates with his investors directly and informally – with concision and clarity.
  • Small boards – 12. All board members must have significant personal capital in Berkshire Hathaway. No insurance for directors. Minimal fees.
  • MANAGER / INVESTOR / PHILOSOPHER!!!!!

VIII. THE OUTSIDER MINDSET

“You are right not because others agree with you, but because your facts and reasoning are sound.” – B. Graham

“What makes him a leader is precisely that he is able to think things through for himself.” – W. Deresiewicz

Lessons that stand out:

  1. Always do the math
  1. The denominator matters
  1. A feisty independence
  1. Charisma is overrated
  1. A crocodile like temperament that mixes patience…with occasional bold actio
  1. The constant application of a rational, analytical approach to decisions large and small.

THEIR BLUEPRINT – they disdained dividends, made disciplined (occasionally large) acquisitions, used leverage selectively, bought back a lot of stock, minimized taxes, ran decentralized organizations, and focused on cash flow over reported net income.

THEIR ADVANTAGE OVER THEIR PEERS WAS TEMPERAMENT OVER INTELLECT. . . WHAT MATTERED WAS CLEAR-EYED DECISION MAKING . . . THEIR CULTURE WAS ABOUT OLD FASHIONED FRUGALITY, PATIENCE, INDEPENDENCE, AND (OCCASIONAL) BOLDNESS, RATIONALITY AND LOGIC.

EMA: Again, in ending, we need to take these examples in context. Not all of this is for us, nor should it be. Our tax world for dividends is lower. Our stockholder wishes our risk appetite are different. But some things are probably wise across the board, like focusing on cash flow over net income.