‘Past performance is no guarantee of future performance.’ Like a food label warning that your favourite box of chocolates may contain traces of nuts, we’ve all read something similar when analysing the performance of a fund manager.
But this warning also applies to individual stocks. Just because a stock has a stable history, for instance, doesn’t mean its future is assured. Do you remember Allco or Nokia? Each were coveted growth stocks before they were swiftly knocked off their perch.
As long term investors, we’re always looking for reliable indicators that can help us beat the market. One of the best is finding owner-managers i.e. companies where management has a large stake in the business. Let’s look at the performance of three owner-managers that feature in our portfolio.
John Malone
John Malone is the doyen of the US cable TV industry and the lead protagonist in the book Cable Cowboy. He produced 30% annualised returns as CEO of TCI between 1973 and 1999 (twice that of the S&P500 – see Chart 1) before selling the company at the height of the tech boom to AT&T.
Chart 1. TCI returned 30% p.a. between 1973-1999
Source: Center for Research in Security Prices (CRSP) and TCI annual reports
From the ashes of the tech wreck that followed, Malone emerged with a large stake in Liberty Media, which spawned numerous companies with interests in cable TV content and distribution, satellite radio and broadband internet, just to name a few.
We own several Liberty names with businesses diversified by industry and geography. They don’t typically screen well due to a host of factors. Management focuses on maximising free cashflow to buy back shares rather than reporting high current profits that attract high taxes, for example, which depresses return on equity even though the company produces high returns on investment.
As complications like this keep most investors away despite management’s remarkable track record, we’ve no problem taking advantage of the discounts overlooked by others.
Paul Saville
Paul Saville watched the original incarnation of homebuilder NVR go broke before becoming CEO in 2005. Unlike virtually every other listed homebuilder on the planet, he learned from the experience and constructed a way to protect NVR from recessions.
Instead of dangerously leveraging the balance sheet to accumulate land for development, NVR lays down 10% of the purchase price for an option on future development. This means the balance sheet isn’t highly geared, allowing the company to buy back 75% of its shares on issue over the past 20 years. That’s a remarkable feat for any company, yet alone a home builder.
In 2009 NVR was the only listed US homebuilder to make a profit and post respectable shareholder returns through the GFC (see Chart 2). With US housing stock now reaching record lows, interest rates still low and the millennial population – the country’s largest ever – reaching a median age that suggests they’ll soon start having families of their own, the company is well placed to benefit from an increase in homebuilding. If housing doesn’t pick up, we expect the company to buy back plenty more shares.
Chart 2. NVR 10 year total shareholder return vs competitors as at 31 December 2015
Source: NVR annual reports
Richard Liu
Richard Liu is the founder of Chinese online retailer JD.com. He’s fanatical about delivery times, the condition of the goods once delivered and eradicating fakes, which is a huge problem in China.
While its larger rival Alibaba measures delivery times in days, JD.com measures them in hours, usually promising same day delivery if you order before 11am. This incredible feat reflects huge long-term investments in warehouses and delivery fleets, which Alibaba has avoided to keep current profits as high as possible. It also required a culture change in an industry not usually associated with caring much for the state of parcels to be delivered.
Over time we expect JD.com’s delivery advantage will allow the company to expand its range of goods and take market share from Alibaba. But it requires Liu’s fortitude to sacrifice profits today for much higher profits tomorrow.
No guarantees
Investing in businesses with large inside ownership is no guarantee of high returns, but the successful operators have common traits.
First, they think long term. After investigating stocks in the S&P500, Ronald Anderson and David Reeb discovered that founding shareholders are more likely to invest in long-term projects and think harder about succession planning.
This contrasts with typical corporate behaviour, or the ‘institutional imperative’ as Warren Buffett calls it, where executives favour high immediate earnings and share buybacks over long term investments to maximise bonuses at the expense of the long-term health of the business.
Inside-owners are often more entrepreneurial, and aren’t afraid to do something different if it makes financial sense. Note NVR’s unique land acquisition strategy, or JD.com’s expensive supply and distribution strategy compared to Alibaba’s preference to outsource its delivery to maximise current profits.
They’re also smart about acquisitions. They don’t bet the company, and are typically buying valuable assets in downturns while their contemporaries are busy fortifying their balance sheets.
According to research by von Lilienfeld-Toal and Ruenz, ‘The acquisition activity of firms with high ownership is significantly lower than that of low ownership firms… Overall, these findings suggest that high ownership firms engage less in empire building’.
Though owner-managers are more interested in increasing profits than owning marquee businesses for bragging rights, they aren’t usually driven by greed. Charles Schwab, who founded stock brokerage company Charles Schwab Corporation, explains why this unique group often keeps working decades after they became wealthy.
l‘The man who does not work for the love of work, but only for money, is likely to neither make money nor find much fun in life.’ In short, they work because they enjoy it.
In an environment where revenue growth is hard to come by, we believe entrepreneurial managers are worth their weight in gold as they adapt to keep their businesses growing. Our job is to keep finding more of these talented individuals to partner with so that your savings continue to grow alongside theirs.
Disclosure: Peters MacGregor Capital Management Limited holds a financial interest in JD.com, Liberty Broadband and NVR through various mandates where it acts as investment manager.
