How great CEOs manage cash
In the book, we promote the idea of measuring the success of a CEO in terms of the value created for shareholders, and in that regard there is no doubt that Jack Welch has been one of the greatest of all time: as the CEO of GE, Jack grew the company’s profits tenfold and outperformed the S&P 500 Index by 3.3 times.
Those are exceptional results by any standard, earning Jack his spot on the list of the greatest, but with most references pointing at his performance in GE as the go-to example for a well- managed organization, we couldn’t help but wonder whether any other company has had an equal or superior performance to GE under Welch.
That is the question that Harvard Business School professor and venture capital investor William Thorndike set out to answer.
He worked with his second-year students at Harvard to look for companies and CEOs that achieved superior performance when compared to Jack Welch’s GE and their industry peers.
The results of Thorndike’s research, published in his book The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success, became an instant hit among executives around the world.
Looking through the archives of the Harvard Business School, Thorndike and his students established two basic tests that a CEO had to pass to be considered exceptional: first, the stock had to have better performance relative to the S&P 500 than GE under Jack Welch, and second, they had to materially outperform their peer group.
Surprisingly, Thorndike’s research found eight companies that passed those two tests: Capital Cities under Tom Murphy (1966-1996), Teledyne under Henry Singleton (1960-1989), General Dynamics under Bill Anders (1991-1993), TCI under John Malone (1973-1998), The Washington Post under Katharine Graham (1971-1993), Ralston Purina under Bill Stiritz (1981-2001), General Cinema under Dick Smith (1962-2005) and Berkshire Hathaway under Warren Buffett (since 1965).
When compared to the performance of this exclusive group, GE’s results under Jack Welch look pale. On average, these fairly unknown CEOs outperformed the S&P 500 over 20 times and their peers by seven times, which sets a much higher bar for what “outstanding” means when it comes to the job of the CEO.
Over the following years Thorndike, with the help of his students at Harvard, dissected the management practices of each of these CEOs to understand what made them so successful and not so surprisingly, they found that they all shared one thing in common: they were great Capital Allocators.
They were all masters in the art of managing the company’s financial resources to maximize value for shareholders.
|CEO||Company||Period as CEO||Stock’s Compound Annual Growth Rate (CAGR)||Factor by which the stock outperformed the S&P 500|
|Jack Welch||GE||1981-2001||20.9 %||3.3 Times|
|Tom Murphy||Capital Cities||1966-1996||19.9 %||16.7 Times|
|Henry Singleton||Teledyne||1960-1989||20.4 %||12 Times|
|Bill Anders||General Dynamics||1991-1993||23.3 %||6.7 Times|
|John Malone||TCI||1973-1998||30.3 %||40 Times|
|Katharine Graham||The Washington Post||1971-1993||22.3 %||18 Times|
|Bill Stiritz||Ralston Purina||1981-2001||24.0 %||4 Times|
|Dick Smith||General Cinema||1962-2005||16.1 %||16 Times|
|Warren Buffett||Berkshire Hathaway||Since 1965||20.7 %||Over 100 times|
Table: Performance of the stock under each of Thorndike’s outsider CEOs.
In general, there are some common factors that separate Thorndike’s outsider CEOs from other executives:
- They religiously devoted an important amount of their time to making capital allocation decisions.
- Their favorite metric for growth was long-term value per-share, rather than sales growth or market share.
- They rarely paid dividends, considering them tax inefficient, and instead compensated shareholders through large stock buybacks.
- Their management focus was not sales or operating margins but cash.
- They seldom relied on the advice of external consultants, and instead based capital allocation decisions, including acquisitions, on their own analysis and the work of their in-house teams.
Notable within this group of CEOs is Warren Buffett of Berkshire Hathaway, who for many experts is the greatest investor of all time.
During his time as CEO, he has outperformed the S&P by more than a hundredfold, and the value of his company’s shares has grown at an average compound rate of 20.7 percent per year.
A $10,000 investment in Berkshire Hathaway in 1965 would have been worth $88 million by the end of 2017, an outstanding result compared to the $1.3 million that the same investment would be worth had it been made in the S&P 500.
Warren Buffett has always talked openly about his investment decisions and over the years has offered some insights that executives paying attention can use to improve their own businesses.
For example, Buffett has a preference for businesses that can produce lots of cash, with strong brands or a dominant market position and low levels of debt, and he loves companies that can make money through franchises (like Coca-Cola for example).
Buffett also prefers to invest heavily in industries that he knows well rather than diversifying across multiple industries, and notably keeps capital allocation decisions tightly centralized at the headquarters.
Success as a capital allocator depends to some extent on the ability to raise cheap money and redeploy it onto higher return activities with perfect timing, a seemingly simple maneuver that has a profound impact on a company’s bottom line.
For more information, see our Capital Allocation section where we explore some of the best capital allocation practices and provide a few ideas that can help evaluate capital allocation decisions.
Wu, Sun. Strategy for Executives, this book can now be downloaded for free here.
Thorndike, William N. The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. Harvard Business Review Press. Kindle Edition.
Maxfield, John. An Interesting Chart About Berkshire Hathaway. The Motley Fool. July 2017.