By Nelson DeMestre | Associate Analyst at NAOS Asset Management
“The goal is not to have the longest train, but to arrive at the station first using the least fuel” Tom Murphy, Capital Cities
The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success” by William Thorndike, Jr.
This book is an extremely interesting and easy-to-read selection of the best CEO allocators of capital in the last few decades. What makes these examples interesting is how diverse they are, in some cases diametrically opposed to each other (one rushed to pay down debt while others used it strategically).
All however believed “the key to long-term value creation was to optimize free cash flow” and that the underlying business performance (rather than promotions and gimmicks), is what generates shareholder returns.
This led each CEO to direct their focus on select variables, differing across the managers:
- Warren Buffett at Berkshire Hathaway: Generation and deployment of insurance float.
- Bill Anders at General Dynamics: Divestment of non-core businesses.
- Katharine Graham at The Washington Post: Kill debt, increase EPS and careful capital expenditure.
- John Malone at TCI: Pursuit of cable subscribers.
- Tom Murphy at Capital Cities: Enter industries with favourable economics, improve operations and pay down debt.
- Dick Smith at General Cinemas: “Cash Earnings” and focus solely on core competencies.
- Henry Singleton at Teledyne: Stock buybacks.
The common denominator between these approaches is that they are remarkably simple to explain and understand, when viewed in retrospect.
The simplicity of Singletons approach for example, brought a 40x rise in EPS over thirteen years, despite sales only doubling over the same period. This was achieved through the buying back of over 90% of shares issued, while using a degree of leverage. Singleton believed, along with the other 7 Outsider CEOs that one must “focus on cash flow and to forgo the blind pursuit of the Wall Street holy grail of reported earnings”, reducing shares on issue and building underlying value, the Teledyne stock price averaged a CAGR of 20.4% (versus 8.0% for the S&P 500).
Some overlapping strategies included:
Efficiency of Capital Allocation
Charlie Munger put Berkshires success down to its ability to “generate funds at 3% and invest them at 13%”, while Tom Murphy used a return target for all acquisitions of “double digit after-tax returns over ten years without leverage”.
Meanwhile, John Malone held himself to a simple rule of acquiring companies on no more than “five times cash flow…, it did not require extensive modelling or projections.”
Monitoring Share Count Closely
Dick Smith “disdained equity offerings”, priding himself on a flat share count: “We never issued any stock. I was like a feudal lord, holding onto the ancestral land”
Enabling Compounded Earnings
“Buffet has in effect created a capital ‘flywheel’ at Berkshire, with funds used to acquire full or partial interests in other cash-generating businesses who earnings in turn fund other investments, and so on.”
Link to Book
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