When we invest, we invest in companies. Either we buy small portions or large stakes but whichever size you take, we’re inevitably staking a position in an organisation. And the concept for successful investing in businesses is quite simple: Find a quality business, buy it at a reasonable price, watch it grow, and then succeed as an investor.
Q3 2020 hedge fund letters, conferences and more
Of course, whilst the steps are simple in principle, its not always that easy. First you have to find the great business. But what makes a quality business? To answer that, let’s get back to first principles.
A Successful Business Is Not Machines Or Buildings But People
Can you touch a business? Can you feel it? Can you see it?
These are some of the critical questions posed by Dee Hock, the founder of Visa. Hock’s book, ‘One from Many - VISA and the Rise of Chaordic Organization,’ considers businesses in a different light; not tangible, physical realities such as buildings or machines, but people. He un-peels the onion so to speak, creating a mental exercise to emphasise the point.
“Fix the company you work for, or any other organisation of which you are part, firmly in your mind. Not its physical manifestations such as its name, employees, or offices, but the company itself. Put all thoughts aside and fix the organisation itself firmly in mind.
Surely you have seen it. What colour is it? No? Well, then you must have smelled it from time to time. Describe its odour. No? Then surely you’ve tasted it. Is it sweet, tart or bland? You don’t know? Well, you must have touched it often. Is it hot or cold, hard or soft? No? Then, without a doubt you have heard it. Make its sound. No? Can you perceive the company you work for, or any other organisation, whether political, social, or commercial, with any of your senses? Obviously not. If you can’t perceive an organisation with any of your senses, does it have any reality at all? Perhaps it’s a fiction. Perhaps it doesn’t exist. But you’re not going to accept that explanation.
The truth is that a corporation, or for that matter, any organisation, has no reality save in the mind. It is nothing but a mental construct to which people are drawn in pursuit of common purpose; a conceptual embodiment of a very old, very powerful idea called ‘community’.
All organisations can be no more or less than the moving force of the mind, heart, and spirit of people, without which all assets are just so much inert mineral, chemical, or vegetable matter, by the law of entropy, steadily decaying to a stable state.”
The Peugeot Lion
Yuval Harari, author of the wonderful book, ‘Sapiens’ makes a similar point. He uses the Peugeot Lion, the icon adorning the cars made by one of the oldest and largest of Europe’s car makers, as an example. Harari explains, ‘Today Peugeot SA employs about 200,000 people worldwide, most of whom are complete strangers to each other. These strangers co-operate so effectively that in 2008 Peugeot produced more than 1.5m automobiles, earning revenues of about 55 billion euros.’
‘In what sense can we say Peugeot SA (the company’s official name) exists?, Harari asks. ‘There are many Peugeot vehicles, but these are obviously not the company. Even if every Peugeot in the world were simultaneously junked and sold for scrap metal, Peugeot SA would not disappear. It would continue to manufacture new cars and issue its annual report. The company owns factories, machines and showrooms.' Peugeot is ‘a figment of our collective imagination.’
Harari concludes, ‘Any large scale co-operation is rooted in common myths that exist only in people’s collective imagination’. Companies fit that bill. Veteran Fortune 500 leader, James Autrey agrees, “There is no business, there are only people. Business exists only among people and for people.” And that applies to all businesses.
“Whoever you are, reader, your organisation is not different. You may have a different product or a different mission, a different organisational structure, or a different management style. You may have a unique manufacturing process or distribution system, or, if you're a non-profit, a special way of fund-raising or delivering services. You may have a lot of things that are different. But fundamentally, your organisation is not different, because it depends on people, and it is that dependence on people that makes you and your organisation far more similar to, than dissimilar from, your counterparts and their organisations elsewhere.” James Autry
Two of the foremost business experts in the world, Thomas Peters and Jim Collins, both recognised that the foundations for all great businesses is people.
‘The starting point for everything is the people.’’ Jim Collins
“Treating people – not money, machines or minds - as the natural resource may be the key to it all.” Thomas Peters
The Importance Of Culture
When you delve behind a company’s assets, whether it be brands, factories, mines or services, you’ll find people. People that are coming together for a common purpose to achieve a goal. The glue that keeps these people together is the culture.
“Healthy organisations are a mental concept of relationship to which people are drawn by hope, vision, values and meaning, along with liberty to cooperatively pursue them. Healthy organisations educe behaviour.” Dee Hock
“Since the strength and reality of every organisation lies in the sense of community of the people who have been attracted to it, its success has enormously more to do with clarity of a shared purpose, common principles, and a strength of belief in them, than with money, material assets, or management practices, important as they may be.” Dee Hock
Even a business with product differentiation, valuable intellectual property or patents must evolve; competitors innovate, patents expire and technological advantages become redundant. The necessary process of constant evolution is ultimately driven by people.
“Businesses evolve, people matter.” Scott Miller
“The only moat that is not fleeting, and conversely the only moat that is truly enduring, is culture.” Chris Begg
“Culture trumps everything else in the long term.” Helen Xiong
Successful businesses have strong management teams which value and empower their people, they promote innovation and risk taking, encourage ownership, and adopt appropriate incentives through the full rank and file of the organisation. It’s little wonder the world’s top CEO’s and the investment industry’s sharpest minds focus on people and culture.
“The force that creates one company in an industry that is an outstanding investment vehicle and another that is average, mediocre, or worse, is essentially people.” Phil Fisher 1958
“Business don’t succeed or fail. People do.” S Truett Cathy
"Unfortunately, the business is not run by a spreadsheet. The business is run by people.” Brian Niccol
"I’ve always said the two most important assets in an organisation don’t appear on the balance sheet. They are people & brands. I do believe a company’s true value is in people & brands, not the buildings or processes.” Greg Creed
"It's all about the people. The key to a successful business lies in managing and motivating the workforce so that they give their best to the job." Julian Richer
“A lot of people think it is all in the numbers, we think it’s all in the people.” Kurt Winrich
“The two most important things in any company do not appear in its balance sheet: it’s reputation and its people.” Henry Ford
“Many companies have buildings and machines and a lot of real estate, but it’s only people that have a chance to make any difference.” Eiten Werthheimer, Iscar
Discovering The Qualitative Aspects Of The Business
Finding the historical financial numbers to fill a spreadsheet isn’t hard. Discovering the qualitative aspects of the business which will determine the future numbers is a little more challenging. In large part, these numbers will be determined by the people.
Insights can be gleaned through studying annual reports, management interviews and result transcripts; studying employee and management alignment, incentives, ownership and turnover. When it comes to understanding a company’s culture, employee empowerment, empathy, time horizons, philosophy and motivation nothing beats channel checks. Getting out and talking to ex-management, current and former employees, customers, suppliers, vendors, competitors and anyone else who might affect the company.
Berkshire Hathaway is a powerful example of people making a difference. Prior to Buffett’s acquisition, Berkshire was a failing textile manufacturer. Absent Buffett, there’s zero chance it would be the company we know today. Buffett himself succeeded not only by deploying his investment acumen, but by identifying quality people to oversee the business units. He attracted and assimilated the high quality people from the dozens of acquisitions to continue their role within Berkshire.
“We tend to overestimate our ability to forecast financials and underestimate the role of people and our ability to spot them. When the new CEO took the reins at Berkshire Hathaway, it was not the economics of the textile industry that determined the outcome. In many of the investments I can think of, it was the people that were crucial. And I would suggest we should be a little bit more skeptical about our ability to build excel models and valuations and calculate margins of safety and this type of quantitative stuff, and give ourselves a little more credit on our ability to think about people." Robert Vinall
“Our job is not so much to select great managers, because we do have this proven record that they come with. Our job is to retain them. And a majority of the managers that work at Berkshire — are independently wealthy. We hand them checks, sometimes, in the billions, often in the hundreds of millions. So they do not have a monetary reason to work, in many cases. We are dependent on them, incidentally. I mean, we have 19 or so people at headquarters, and we have 250,000 working for Berkshire around the world, and we can’t run their businesses. Our job is to make sure that they have the same enthusiasm, excitement, passion, for their job after the stock certificate changes hands, than they had before.” Warren Buffett
What Makes A Business Successful?
Ask yourself this: What is the one thing, in the absence of all else, that makes a business successful? That is to say, if nothing else was available to ensure you had a business and that it ran effectively, what would it be? Is it the products? The brand? The corporate structure? The pricing? The quality of the supply chain and warehouse? The business model? The value of the stock? In the end, it’s none of these things. While each is important, if you don’t have capable, engaged and empowered people, none of the other things matter.
The really important mental model to take away from this is, that when you’re investigating an organisation as a potential investor, the computer screen ain’t gonna provide all the answers. Study the people! Only then can you determine the culture of the organisation. Only then can you understand the value of the people within. Because until you do, the business you’re looking at, remains a figment of your imagination…
Further Reading:
‘Culture - Tutorial’ - Investment Masters Class.
‘The IMportance of Culture’ - Investment Masters Class 2017.
‘Widening Moats and Culture’ - Investment Masters Class 2018.
