Capital Allocation
We are all capital allocators. Money in, money out. Prioritization. Competing interests. Opportunity cost. Taxes. Retirement or education? Should we buy this investment property? Renovate the house? Pay down debt? Send the kids to private school? And what the heck do I do with my company stock? These are all among the many decisions that dictate the progress of long-term wealth creation.
William Thorndike's book, The Outsiders boils down what makes a great CEO. Thorndike defined the hallmark of exceptional CEO performance as 'the returns for the shareholders of that company over the long term.' Throughout the book, there were many parallels between how these CEO's ran their respective organizations, and how individuals can achieve success managing their own personal finances.
Below are a few of my favorite snippets from the book, along with some corresponding thoughts on application to financial planning. I highly recommend the read if you're interested in being a better leader or a better investor.
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"CBS spent much of the 1960s and 1970s taking the enormous cash flow generated by its network and broadcast operations and funding an aggressive acquisition program that led it into entirety new fields; including the purchase of a toy business and the New York Yankees baseball team. CBS issued stock to fund some of these acquisitions, built a landmark office building in midtown Manhattan at enormous expense, developed a corporate structure with forty-two presidents and vice-presidents, and generally displayed what Buffet's partner, Charlie Munger, calls "a prosperity-blinded indifference to unnecessary costs.""
Matt - It's not about what you make, but what you keep. The ability for anyone to manage their burn rate is (in my opinion) the number one factor in creating long-term wealth. Who would you consider more wealthy? Someone with $6k of passive income per month (pensions, social security etc.) who is spending $3k per month. Or, someone bringing in $50k of employment income per month, who is spending it all? I'll take the former - many times, wealth is built on what you DON'T buy.
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"(Henry) Singleton eschewed detailed strategic plans, preferring instead to retain flexibility and keep options open. As he once explained at a Teledyne annual meeting, "I know a lot of people have very strong and definite plans that they've worked out on all kinds of things, but we're subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible. In a rare interview with a BusinessWeek reporter, he explained himself more simply: "My only plan is to keep coming to work. . . . I like to steer the boat each day rather than plan ahead way into the future.""
"Applying his engineering mind-set, (John) Malone looked for no-brainers, focusing only on projects that had compelling returns. Interestingly, he didn't use spreadsheets, preferring instead projects where returns could be justified by simple math. As he once said, "Computers require an immense amount of detail...I'm a mathematician, not a programmer. I may be accurate, but I'm not precise."
Matt - I think these were my favorite passages in the book. Here you have, by any account, two of the most successful CEO's in history acknowledging the lack of projections, forecasting and precision used to run their day-to-day business. Being too reliant on precision and predetermined outcomes reduces the margin of safety required when things inevitably go wrong. As is relates to financial planning, we always say not to bank on the outcome of a single plan. Inflation for the next 40 years could be 2% or 4%. Average returns could be 5% or 7%. Life expectancy could be 14 more years or 42 more years. Using assumptions with such wide variances has significant impact on plan projections - and things can change quickly. Be committed to the process of planning, simplicity and flexibility. Make small improvements consistently. Steer the boat each day.
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"During the extended bear market of the mid-1970s to early 1980s, (Tom) Murphy became an aggressive purchaser of his own shares, eventually buying in close to 50 percent, most of it at single-digit price-to-earnings (P/E) multiples."
"When asked to summarize what made Stiritz different, (Michael) Mauboussin told me, "Effective capital allocation...requires a certain temperament. To be successful you have to think like an investor, dispassionately and probabilistically, with a certain coolness."
"Malone's entire future career can be thought of as an extended exercise in hyper efficient value engineering, in maximizing output in the form of shareholder value and minimizing noise from other sources, including taxes, overhead, and regulations."
"Although frugal by nature, the outsider CEOs were also willing to invest in their business to build long-term value. To do this, they needed to ignore the quarterly earnings treadmill and tune out Wall Street analysts and the cacophony of cable shows like Squawk Box and Mad Money, with their relentless emphasis on short-term thinking. When Tom Murphy insisted on a huge spike in capital expenditures for a new printing plant or when John Malone bought expensive cutting-edge cable boxes in the late 1990s, they were consciously penalizing short-term earnings to improve their customers' experiences and defend long-term competitive positions."
Matt - true opportunity comes when it gets hard. Be prepared to shop when the market goes on sale. Limit noise (turn off the news and stop checking account balances constantly). Most times, reaping longer term benefits requires short term pain.
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And lastly, a flat out inspiring story. Katharine Graham had to overcome her husband's tragic suicide in 1963 while simultaneously taking over his position as CEO of the Washington Post Company. If you're overcome with self-doubt regarding a promotion or job change, consider Katharine's story. Sometimes, we all have way more to give than we give ourselves credit for.
"It is impossible to overstate (Katharine) Graham's unpreparedness for this position. At age forty-six, she was the mother of four and hadn't been regularly employed since the birth of her first child nearly twenty years before. With Phil's unexpected death, she suddenly found herself the only female chief executive of a Fortune 500-size company. Naturally shy, she was understandably terrified. This story, although remarkable, is well known (the best version by far being Graham's own Pulitzer Prize-winning autobiography, Personal History, published in 1997.) What's less well appreciated is what Graham did for her shareholders. From the time of the company's IPO in 1971 until she stepped down as chairman in 1993, the compound annual return to shareholders was a remarkable 22.3 percent, dwarfing both the S&P (7.4 percent) and her peers (12.4 percent.) She was simply the best newspaper executive in the country during this twenty-two year period by a wide margin."
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Source: The Outsiders, by William N. Thorndike, Jr.
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