Don’t Forget The CEO When Evaluating A Firm

Don’t Forget The CEO When Evaluating A Firm

“Davidson” submits:

Play Quizzes 4

Would you believe it is not math but empathy which is the key?

“Empathy is the capacity to understand or feel what another person is experiencing from within the other person’s frame of reference, i.e., the capacity to place oneself in another’s position.”

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Learning which information carries the highest investment value is what makes the difference between better investors and less than average performance. The drive to employ evermore powerful computers and sophisticated algorithms misses the fundamental basis that it is individuals who invent and create value. Corporations do not self-assemble and produce iPhones or cures for Hepatitis C. Only individuals do this!

Learning to identify the individuals who create value and manage capital successfully is the basis of being a Value Investor. Listen carefully to Warren Buffett, Ken Langone, Leon Cooperman or any successful Value Investor and you will hear them discuss the qualities of the CEOs in which they invest. Good CEOs do far more than produce good financial performance. They can be trusted more than any others when they explain their business philosophies, offer their perceptions of the current business climate and provide an overall investment context. The better CEOs provide fundamental investment insight not available from any other source. Empathy is how one learns to trust this source of investment intelligence.

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‘Empathic Logic’ is the process of connecting CEO/manager skills with security performances. Empathic Logic is a developed skill. One learns though careful analysis over time how a particular individual thinks. One makes connections between individual skill sets, financial performances and extends this to how the market prices securities. Each security has unique pricing based on historical performance and investor perception. Understanding a particular market valuation requires understanding this mix of tangibles and intangibles deploying one’s Empathic Logic.

While markets operate in an environment of continuous flux, individual personalities and skill sets do not change. Once an investor has developed an understanding of individuals’ skill sets, one can trust that over time they will likely repeat past outperformances. Not only will they likely outperform financially, the securities of their companies typically outperform and their business/economic commentary often provides the best continuous stream of investment insight available. The greatest investment risk occurs when a CEO one does not know well replaces one who is a known quantity. We saw this type of risk balloon in 2008-2009 when Hank Greenberg was replaced by an unknown at AIG. Danaher’s corporate culture is a prime example of a corporate culture which produces manager successions with skill sets well-tuned to the nature of its business. Danaher’s successful CEO successions are the basis for long-term security performance.

In the Russell 3000, one can identify ~300 CEOs (~10%) who outperform the index which can form the basis of diversified portfolio of 40+ issues.  Essentially, once one identifies good management, one can trust it to perform in the future. Human personalities do not change over time. Human behavior is such that someone who has developed the complex skills needed to manage an enterprise successfully through circumstances which change unpredictably will more than likely continue to do so. Empathic Logic is the heart of assessing people skills, making the connections between people, financials and security prices. This is what Value Investors do best, but rarely discuss in detail. If one listens carefully, one will hear them speak of the quality of the people managing the companies in which they are invested.

The investment recipe then becomes:

  1. Identify good managers, measure their financial performances and market pricing.
  2. Buy good managers when markets underprice long-term performance, ie: when markets are out of sync with economic fundamentals.
  3. Hold till the economic/market cycle peaks or a change in CEO management style changes.

The group of CEOs and portfolio managers whose collective commentary becomes the basis for judging business/economic data becomes a ‘Virtual Staff’. My ‘Staff’ comprises more than 200 highly skilled individuals. Investment insights fill my InBox everyday. It is the combination of trusted CEOs and portfolio manager insight (‘Bottom Up’) with broad market indicators (Top Down’), analyzed daily, which forms the overall context for individual market suggestions.

In my opinion, this is the most effective approach for ‘Modern Security and Market Analysis

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Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.
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  1. How can I judge a CEO from my computer?

    I read the earnings call transcripts and get interviews (if there are any) with them on Youtube, but that’s about it.

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