Some of the most successful companies of the last half-century all had one thing in common. And I am certain that the best investments of the next half-century will also share this trait. It’s pretty simple and intuitive, yet I wonder why more investors don’t focus on it.
I’ll use a simple analogy to reveal this idea. Let’s say we have two houses. In one, the family that lives there also owns it. In the other, there is an absentee owner who rents it out. If you had to guess which house would be in better shape after 10 years, which would you guess?
If you said the former, where the people who lived there owned it, odds are you’d be right. (There are always exceptions.) It’s a truism in real estate that owners take better care of property than renters.
The same kind of logic applies in the stock market. When the people running the show are also owners – what’s known as the owner-operator model – those companies tend to deliver astonishing results over time.
Steve Bregman, a portfolio manager at Horizon Asset Management, recently shared a little experiment. He looked at “the most successful, iconic constituents of the S&P 500 over the past half century.” The impact of OOs was clear.
These include Wal-Mart. “Think how well it did under the aegis of Sam Walton for 20 years,” Bregman says. Wal-Mart delivered a return of 20.5% annually. But after him, Wal-Mart returned only about 9% per year. Then, there is also IBM. Under the Watson family, IBM returned 6.6% more than the stock market. After the Watsons, only 1.7% better than the market. “Good, but not great,” Bregman says.
The most recent example of an OO’s impact is Apple. Without Steve Jobs for over a decade, Apple turned in a return of 3.1% per year worse than the market. With him, 28% per year better. For the whole list, give the following table a look.
Granted, this is not a scientific experiment, as Bregman notes. (There is scholarly research out there that backs the idea that stocks with owner-CEOs outperform.) But it does show you the importance of that OO.
In only two instances did the company under the OO trail the market. Even then, there is a big qualifier. The table shows that during Jobs I, his first tenure as CEO, Apple trailed the market. But it was only a four-year stretch, which he more than made up for later. And in any event, the table shows results only since the company has been public. If you consider the wealth created by Apple’s initial public offering, a different picture emerges. Apple’s IPO created more millionaires than any company in history. The original venture capitalists that backed Jobs made billions.
There is another advantage to OO-run companies that Bregman points to. The stocks have a low correlation to the S&P 500. In other words, returns were not as sensitive to the overall market as other stocks. Remember, a correlation of 1 means the stock matched the S&P 500 exactly. The lower the number, the less sensitive the stock to overall market movements.
On average, the OOs had a correlation of only 0.52. By contrast, the average of the largest 50 companies excluding the OOs is about 0.70. That is a big difference and meaningful when building a portfolio. The OOs are your stalwarts. They tend not to mirror the broader market.
In any case, this little experiment shows that there is something different about the decision-making process of an OO-run company and that of an ordinary company – and it shows up in returns.
As Bregman points out, there are strategic and tactical advantages to being an OO. You can make decisions that are “at dramatic odds with the mainstream [whereas] most company managements are highly reactive to investor concerns.” OOs focus on the business because they own it. They don’t worry about the short-term stock price. Hired-gun CEOs think differently.
For example, the typical company today has accumulated cash, preparing for known risks, waiting for the “all clear” sign before investing. It seems like a good idea, but it’s not what creates great piles of wealth. As Bregman puts it, they are “reacting to a crisis that already happened.”
By contrast, look at the OOs. OOs accumulated cash before the downturn. So rather than continuing “to husband cash, they have been investing it assertively for the last two years.”
Bregman gives an example from his portfolio, AutoNation. There are 13% fewer dealerships than there were in 2008, which sounds very scary. Yet AutoNation repurchased 17% of its shares during this rough period. The stock today is at 52-week highs and that investment paid off handsomely.
Our portfolio is full of such companies that continued to invest cash in dangerous times. Ironically, it is during such times when investing is safest, because the prices you get are the most attractive. And the assets so acquired become the foundations for great success later on.
So that’s the case for OOs in a nutshell. It doesn’t mean there aren’t great investments without OOs. But OOs do tip the odds in your favour.
On behalf my subscribers to Capital & Crisis, I prefer to invest in owner-operators. Failing that, I seek managers who show an owner’s mind-set. The main point is to think about who owns and controls what we are investing in.