This is how newspapers picture the greatest CEOs of our time.
Someone who is charismatic and action-oriented.
Someone who has a fancy office, preferably in a fancy place like Manhattan with hordes
of underlings with MBAs.
They also picture this CEO to be someone who flies a lot on corporate jets.
But they are totally wrong.
Actually, the most outstanding CEOs of our time, the "outsiders", have been pretty much
the polar opposite of what I just described.
CEOs operate in a highly quantifiable universe, but many people miss this point.
We understand things such as batting averages in baseball, numbers of goals scored in football,
or a number of title defenses in the UFC.
But what is the equivalent in the corporate world?
It's the increase in company per share value.
We are not talking about absolute returns here, but returns relative to peers and the
overall market.
And let's just say that the outsiders performed quite well here.
On average, they outperform the S&P 500 by 20 times, and their peers by seven times.
So, one can definitely say that there are incentives for an investor to learn how to
detect these types of people.
And that is what you will learn in this video.
In this video, I will present the five most important traits that an outstanding CEO possesses
based on my own opinion after reading the book, The Outsiders, which is written by William
Thorndike.
This is the Swedish investor, bringing you the best tips and tools to reach financial
freedom through stock market investing.
Trait number one: They are skilled investors.
CEOs must do two things very well; they must run their businesses efficiently and they
must deploy the capital that these businesses generate.
Which one you think is the most important?
Unlike what I think most people believe, it is the second one.
The CEO of an established firm must know how to allocate cash to profitable projects.
In other words, CEOs are investors.
It is an interesting dynamic of corporate life because skills in capital allocation
is usually not what earned the person the CEO position to begin with.
Warren Buffett, one of the outsiders CEOs and the greatest investor of all time, says
the following about this strange dynamic, "To stretch the point, it's as if the final
step for a highly talented musician was not to perform at Carnegie Hall but instead, to
be named the chairman of the Federal Reserve."
CEOs have five basic choices in deploying capital; invest in existing operations, acquiring
other businesses, issuing dividends, paying down debt or repurchasing stock.
And the most successful CEOs tend to focus on three of them...
A CEO's flexibility and proficiency in mixing these three ways of allocating capital is
probably the most important trait for outstanding stock returns.
And sorry to all of you dividend investors out there, but dividends are actually not
something preferable to see in a company that you invest in.
Why?
Because it is taxed at both the firm and the individual level while the other options for
capital allocation are not.
Moreover, it may signal that the firm has limited growth prospects.
The Outsider CEOs use the price of their own share as a benchmark for evaluating other
capital allocation options.
Consider what Henry singleton did with his Teledyne.
He issued Teledyne stock for an average of 25 times the company earnings and bought back
that same stock at an average of eight times.
So, he was buying for eight dollars and selling for twenty-five basically.
Talk about aligning interest with shareholders.
This also happens to be the next trait that you should look for.
Trait number two: They align interests with shareholders such as you and me.
The CEO is hired by the shareholders to benefit the shareholders.
But not all CEOs realize this.
They use their position as the chief to build their own empire, increasing revenues and
the number of employees at all costs.
Shareholders of companies with these types of egocentric CEOs often lose a lot of money.
So, the second trait that we want to look for and that all outsider CEOs had in common
is that they are shareholder oriented.
There are a couple of clues that you can look for.
One; the CEO is invested in the company.
If he holds shares too, that is great.
In these cases, the CEO will most likely work with you.
Two; organization-wide share ownership.
The CEO is the most important one to check, but what's even better is if there are incentives
to spread share ownership in the organization.
Dick Smith of General Cinema for instance, issued options for executives and matched
employees share contributions.
Three; willingness to shrink.
A CEO that is willing to divest or even close unprofitable business units shows that he
doesn't possess that harmful ego of the charismatic and action-oriented CEO that the newspapers
like to picture.
Which is a good thing.
Four; bonus systems.
Katherine Graham of The Washington Post for example, used bonuses as a major tool for
compensation of executives.
Constructed correctly, this aligns interest with shareholders much more effectively than
a flat salary.
Trait number three; they decentralize.
Henry Singleton had 50 people working at his headquarters with an organization of a total
of 40,000 people.
This is pretty damn impressive.
And it's only surpassed by Warren Buffett who has about 30 people working at the headquarters
in Omaha and an organization of no less than 400,000 people.
Most of the outsider CEOs decentralized their businesses.
The individual business units of their oganizations didn't have headquarters watching over their
shoulders all day.
But physical decentralization is just one part.
Even more importantly is how flat the hierarchy of the organization is.
The outsider CEOs prefer to have as few middle managers as possible.
Cutting out the middleman isn't just a strategy for supply chain managers but also for exceptional
CEOs it seems.
Decentralization leads to freed entrepreneurial energy and greater work autonomy.
Tom Murphy of Capital Cities probably said it best.
"Hire the best people you can and leave them alone."
Of course, this trade is strongly tied to trait number two, aligning interests with
shareholders.
Leaving people to do whatever they find best is right out stupid if you don't at the same
time make sure that their incentives are aligned with yours.
Something that's interesting here is that, while CEOs like Singleton and Buffett decentralized
operations almost completely, they also centralized capital allocation almost completely.
Not a single dime was to be spent under their watch without first showing good prospects
for return on that capital.
Trait number four: They focus on cash.
Wall Street loves to focus on quarterly earnings.
The outsider CEOs loves to focus on long-term cash flows.
The best illustration that quarterly earnings can be misleading for how a company really
is performing is provided by John Malone of TCI.
He deliberately made tons of acquisitions within the cable industry and finance these
through a lot of debt.
Why?
Because he realized that by minimizing net earnings through increasing depreciation and
interest payments, the shareholders wouldn't have to pay any taxes at the corporate level.
In this way, he was able to fund investments with pre-tax cash.
It didn't make sense to look at net earnings to see how much value he was creating for
shareholders.
Many of the outsider CEOs came up with their own metrics on how to measure business performance.
John Malone was a pioneer of EBITDA.
As he tried to maximize interest payments and depreciation, it made more sense from
a value perspective to look at this number rather than net earnings.
Dick Smith used something called cash earnings which was defined as net earnings plus depreciation.
And Henry singleton coined the term "Teledyne return", which was an average of net earnings
and cash flow.
And of course, to align interest with shareholders, business managers of Teledyne had their bonuses
tied to this number.
Trait number five: They are frugal.
I think Tom Murphy said it best.
"The goal is not to have the longest train but to arrive at the station first using the
least fuel."
And boy, did he adhere to this himself.
When his company Capital Cities acquired another large media company called ABC, in 1985, he
managed to upset a lot of top executives with his frugality.
No longer would they be able to fly first-class.
And Tom Murphy also removed their private dining room at the headquarters.
Furthermore, he wasn't afraid to lay off people to cut down costs that way.
But the most hilarious example of Tom Murphy's thrift is related to house paint.
Murphy was asked to paint the walls of one of the company studios to project a more professional
image to advertisers.
Seeing the potential of driving more income as a result of this, Murphy obliged but only
partly, 2/4 to be exact.
Because house paint was an expense, it had to be minimized.
So Murphy decided that only the two walls facing the street should be refurbished.
Forever cost-conscious.
"Being a CEO has made me a better investor and vice versa."
Warren Buffett knows what he's talking about.
So whether you are aiming for the top spot of your current company or just want to know
how to allocate the capital that is your salary more effectively, you should check out my
playlist of this legendary man.
Cheers guys.