The intangible part of investment – the people piece (Part 1)
Updated: Apr 8, 2021
Lessons from the research of Jim Collins.
Late last year we spent a lot of time thinking about how investment firms analyse opportunities. In short:
1. The numbers
2. The people
Most organisations have a well-defined process of analysing the financial aspects of an opportunity, but how comprehensively do we assess the people? A CV check of a company’s management team and board member experience? Talking to people in our networks regarding key executives appointed to positions for a reference check? Conducting management meetings?
How does one organise the intangible information collected watching a company execute or speaking with management and put into a sophisticated framework that may inform future results?
For us, investment is an intellectual endeavour. The thinking is what we are most passionate about. I’m not sure we’ll solve the question, but we’ll give it a go over the course of our careers.
At dinner with a friend late last year, I mentioned that we were antagonising over the question. For Christmas, he bought me the book ‘Good to Great’ by Jim Collins, a book he insisted would be a good starting point in thinking about the question. It most definitely was.
Jim Collins, an ex-McKinsey consultant turned researcher and academic sought to identify the common thematics behind companies that had been producing average results for 15 years (stock price vs. index) and, after an inflection point, went on to beat the market by at least 3 times for the next 15 years. The project took 5 years and 21 researchers to complete.
After the screening process, the following companies were found to meet the criteria:
To frame the research appropriately, the team selected a group of “control companies” whose results followed market performance in order to:
Filter for industry and market tailwinds
To not answer the question of what characteristics did the “good to great” companies share in common, but to identify what these companies shared in common that distinguished them from the “control companies”.
The research team then embarked on the exhaustive process of collecting the following for the “good to great” and “control” companies:
All articles published dating back 50 years.
Interviewing the “good to great” executives of the “transition era” extensively.
Collecting M&A data.
Collecting executive compensation data.
Studying business strategy.
Financial ratios analyses.
After collecting 384 million bytes of data, they segmented the data into categories like leadership, technology, strategy etc. The results of the data analysis are counterintuitive:
Celebrity CEOs who are drafted into companies are negatively correlated with going from “good to great”. Most of the “good to great” transition era management personnel were internally promoted.
They found no pattern linking management compensation package structures with the results (We respectfully disagree – see below).
The outperformers did not necessarily spend more time on long-range strategic planning than their peers.
The outperformers spent equal amounts of time thinking about “what not to do” as they did “what to do”.
Technology alone does not create transformational results.
M&A plays no role in igniting transformation to outperformance.
Minimal efforts spent on change management.
There was no single revolutionary programme, acquisition, rebrand, product line that caused the transformation.
Minimal media coverage of the transformations taking place.
What’s interesting to us is that these results are in direct contrast with what the market thinks and how it reacts. In consideration of our question relating to the assessment of the people side of the investment process, we note that the findings of research show distinct behavioural characteristics as the driver behind the outperformance. Here’s the summary:
1. “Level 5 leadership”
The leaders were a paradoxical blend of humility and unwavering will. No rock stars.
2. “First who… Then what”
The leaders first got “the right people onto the bus and the wrong people off” before devising strategy. They enlisted the sort of people who were more inspired by who else was on the bus rather than where it was going.
3. “Confronting the brutal facts”
The companies had the requisite discipline to honestly self-assess what they were doing well and what they weren’t, whilst maintaining an unwavering resolve that they would prevail.
4. “The Hedgehog concept”
A clear understanding of what they could be the best in the world at, passionate about and what drives their economic engine.
5. “A culture of discipline”
The research found that the “good to great” companies did not have bureaucratic organisational structures with excessive controls. Rather they found a pattern of disciplined people who engaged in disciplined thought and took disciplined action.
6. “Technology as an accelerator”
The companies thought differently about technology. They didn’t use technology as the driver of transformation, but pioneered technology in pursuit of being the best in their respective field and/or in driving their economic engines.
Some captivating data-driven conclusions on some of the behavioural aspects associated with these remarkable turnarounds. I find it interesting that the researchers did not find a link between executive compensation, shareholder alignment and share price, as a plethora of other data exists indicating the positive correlation (See Jensen & Zimmerman 1985, Murphy 1985, Coughlan-Schmidt 1985, Benston 1985, Grant & Kirchmaier 2004 and the Principal-Agent study of Berle & Means 1932).
On another note, I was in Melbourne last week meeting with a micro-cap company Harris Technology (ASX:HT8). Their CEO, Garrison Huang is engineering a very similar turnaround whilst inadvertently following a similar process. I look forward to watching this play out through the lens of the Collins research. All the best Garrison and team!
Until next time,