Why You Shouldn’t Invest in a Business That Even a Fool Can Run

[giofranchi]

https://fundooprofessor.wordpress.com:443/2015/03/20/why-you-shouldnt-invest-in-a-business-that-even-a-fool-can-run/

 

 

Gio

[innerscorecard]

I think the problem is naive investors who use quotes like this to justify what is basically single-variable analysis of companies, saying a fool could run X company and it's cheap enough, so it's a Buffett wide moat company that you should hold forever.

[spartansaver]

I don't think the article addressed it's title of why you shouldn't invest in a business even a fool can run, it more gave a few examples of when management may make an average business good or great. Geico was a great business hidden by horrible management and in that case bringing in the right CEO was required.

[Jurgis]

Any company can be destroyed by inept management. If not destroyed, at least the capital can be squandered, moat diminished, and shareholders can suffer permanent loss of capital.

 

There are companies where mediocre management can keep company running and even outperforming benchmarks a bit because of moat. It is still not clear whether it's worth buying stock in such company at a "good" price. (At "great" price - sure ;)  ).

 

But overall, the bigger issue with "even fool can run" statement is that it draws attention away from evaluating the management more precisely than fool or not fool. It's relatively easy to say whether management are fools or not - most of the time they aren't. However, evaluating if they are mediocre or great is much tougher. This can be witnessed by various opinions about Dimon, Moynihan, Ballmer, etc.

 

I can think of the following situations where management evaluation is tough:

- "Stable" company: i.e. company is chugging along, there is no big loss or big gain, but perhaps with great management it would do much better. Boring examples are in insurance: AXS, RE. Perhaps not boring example: MSFT. :)

- "Super" company that has not experienced downturn. Most people think that Musk, Page are great managers, but what happens when TSLA, GOOGL go into downturn? Would they be great then? (Both of these examples might be controversial :) ).

- Company that hits externally caused downturn. Is the management great but suffering because of things they can't control? Or are they lousy because they did not position the company correctly? Examples: MSFT again perhaps, oil companies right now (NOV - wasn't the management "great" so far, but now BRK is selling shares and nobody thinks management is great anymore?), banks in banking crisis, perhaps KO now - is the current CEO mediocre or is the soft drink crisis unavoidable?

 

 

[oddballstocks]

All of these articles and quotes imply that a great business needs to be run by a rocket scientist.

 

Here's an observation I've made.  ALL business is run by fools.  There are few rocket scientists running companies, and if they are they only run it for a short while.  The intelligence needed to run a company is different than the intelligence needed to be a doctor/scientist/engineer.  A successful CEO needs to know how to manage people not fiddle with Excel.

 

Sometimes in the investment world CEO's are held up as these all important genius type people.  I've met a lot of people, from CEO's on down to the worker bees doing the work.  Maybe there is a brand of CEO I've never met, but my experience has been that CEO's are great with people, great knowing a lot of topics, and great knowing how much they need to know.  But if you want to get deep in the weeds the raw intelligence is usually stored in a cube far away from the windows.  The smartest execs know this too.  If asked a very pointed question they will respond with a "You need to talk to xyz."

 

I don't know why we got into this hero worship thing of CEO's, they're just people.  Look at Buffett, his genius is that he doesn't manage (supposedly).  How much intelligence does that take?  He buys a good company and then does nothing.  Literally any fool can do that.  His genius is in knowing which business to buy.  If BRK were to just run forever without every acquiring another company I dont see why anyone on this board couldn't run it.  Hire excellent investment managers, ignore the underlying business and call it a day.  I'm exaggerating to an extent to make the point, but think this through.

[Jurgis]

Oddball,

 

You assume that "fool" just means low intelligence and then you make two mistakes:

 

First, of course CEOs are not necessarily Stephen Hawking intelligence level geniuses. But they are not fools either. They are above average in intelligence.

 

Second, "fool" in the quote meant "not a good leader, manager" too. And you say yourself that the CEO has to be a good leader and manager.

 

Furthermore, I disagree with you that above average intelligence and above average people management skills are enough to make a great CEO. It is actually a rather unquantifiable mix of the two and some other things including being in the right place at the right time with the right mindset.

 

I agree with you that CEOs are not superhuman. But good ones are not average schmoes either.

[constructive]

I think fundooprofessor is missing the point. He shows evidence of companies that Buffett bought because they had great management despite not being in a great industry. But he has also bought many other companies  in great industries that could survive lower quality management.

 

Compare US Air, USG, McLane (bad industry, so the investment depended on good management) to AXP, ABC/Capital Cities/DIS, Gillette/PG (good industry, could have survived bad management). The returns on the latter group have probably been higher.

[giofranchi]

Compare US Air, USG, McLane (bad industry, so the investment depended on good management) to AXP, ABC/Capital Cities/DIS, Gillette/PG (good industry, could have survived bad management). The returns on the latter group have probably been higher.

 

Well, this only proves what I am saying all along: go for a great entrepreneur + a great business + a fair price! Your second list of Buffett's investments imo perfectly fits the description! ;)

 

Cheers,

 

Gio

 

[Liberty]

- "Super" company that has not experienced downturn. Most people think that Musk, Page are great managers, but what happens when TSLA, GOOGL go into downturn? Would they be great then? (Both of these examples might be controversial :) ).

 

Tesla IPO'ed during the financial crisis and almost went bankrupt. Musk basically made it survive through sheer will (and putting every cent he had in it, borrowing money to pay rent). That was a much bigger trial by fire than they are likely to get, since at that time they were a small startup selling a few hundred $100k two-seaters during the worst crisis since the 1930s. They're a much more solid company now. Maybe the stock will go down a lot if multiples compress, but the business itself is more solid than its ever been. Saying they've never been through a downturn is incorrect.

[Jurgis]

- "Super" company that has not experienced downturn. Most people think that Musk, Page are great managers, but what happens when TSLA, GOOGL go into downturn? Would they be great then? (Both of these examples might be controversial :) ).

 

Tesla IPO'ed during the financial crisis and almost went bankrupt. Musk basically made it survive through sheer will (and putting every cent he had in it, borrowing money to pay rent). That was a much bigger trial by fire than they are likely to get, since at that time they were a small startup selling a few hundred $100k two-seaters during the worst crisis since the 1930s. They're a much more solid company now. Maybe the stock will go down a lot if multiples compress, but the business itself is more solid than its ever been. Saying they've never been through a downturn is incorrect.

 

They have never been through a downturn.

 

Startup pains when you have no product and no sales is very different from a downturn.

 

You might be right though that Elon will deal with downturn just fine based on his startup and other company experiences.

[Liberty]

- "Super" company that has not experienced downturn. Most people think that Musk, Page are great managers, but what happens when TSLA, GOOGL go into downturn? Would they be great then? (Both of these examples might be controversial :) ).

 

Tesla IPO'ed during the financial crisis and almost went bankrupt. Musk basically made it survive through sheer will (and putting every cent he had in it, borrowing money to pay rent). That was a much bigger trial by fire than they are likely to get, since at that time they were a small startup selling a few hundred $100k two-seaters during the worst crisis since the 1930s. They're a much more solid company now. Maybe the stock will go down a lot if multiples compress, but the business itself is more solid than its ever been. Saying they've never been through a downturn is incorrect.

 

They have never been through a downturn.

 

Startup pains when you have no product and no sales is very different from a downturn.

 

You might be right though that Elon will deal with downturn just fine based on his startup and other company experiences.

 

The company was founded in 2003. The Roadster was introduced to the public in 2006 and went on sale in 2008. I'd say that the 2008-2009 recession counts as a downturn and not just regular startup pains. They probably would have had lots of startup pains without the 2008-2009 crisis, but with it, they showed incredible resilience. Heck, GM and Chrysler went bankrupt.

[Guest Schwab711]

All of these articles and quotes imply that a great business needs to be run by a rocket scientist.

 

Here's an observation I've made.  ALL business is run by fools.  There are few rocket scientists running companies, and if they are they only run it for a short while.  The intelligence needed to run a company is different than the intelligence needed to be a doctor/scientist/engineer.  A successful CEO needs to know how to manage people not fiddle with Excel.

 

Sometimes in the investment world CEO's are held up as these all important genius type people.  I've met a lot of people, from CEO's on down to the worker bees doing the work.  Maybe there is a brand of CEO I've never met, but my experience has been that CEO's are great with people, great knowing a lot of topics, and great knowing how much they need to know.  But if you want to get deep in the weeds the raw intelligence is usually stored in a cube far away from the windows.  The smartest execs know this too.  If asked a very pointed question they will respond with a "You need to talk to xyz."

 

I don't know why we got into this hero worship thing of CEO's, they're just people.  Look at Buffett, his genius is that he doesn't manage (supposedly).  How much intelligence does that take?  He buys a good company and then does nothing.  Literally any fool can do that.  His genius is in knowing which business to buy.  If BRK were to just run forever without every acquiring another company I dont see why anyone on this board couldn't run it.  Hire excellent investment managers, ignore the underlying business and call it a day.  I'm exaggerating to an extent to make the point, but think this through.

 

+1, this needed to be said! I'm glad you pointed out how "little" Buffett actually does other than make decisions (he does seem very involved in the insurance business and supposedly helped value the $1b March Madness policy for Quicken). This is a really deep conversation so I'm sure my response is incomplete, but the perception investors have of the benefits "great" management provide vs. what they actually provide seems incredibly lopsided. They are really just people. Often times, they are just the company representative and speak as the voice for the collective senior executive opinion and they are not as 'strong' or 'independently decisive' decision makers as they may appear (I'm looking at you Jamie Dimon; and I think he's the best in the business at the moment).

 

The word "fool" has a different meaning to everyone but in general most companies will run fine with 'fools' at the helm (even in the airline industry). From all of our perspectives, they probably seem worse than they are because we all care about excellent capital allocation more than even CEOs care, which is actually just one aspect of their jobs. I think a lot of CEOs that are poor allocators probably know it but there may be other reasons why they can't do what would be considered best. This is really the reason I avoid these companies, management may not have the freedom to operate the business correctly for all sorts of reasons. The article's general idea that because there exist a few examples of great investments in lousy industries due to great management then that means you don't need to keep searching for the highest quality businesses seems the most foolish of all. Great businesses make management and investor lives easier (and they make a ton of freaking money at nearly any price multiple). Determining what those businesses are ahead of time makes a lot of very intelligent folks look foolish and is the reason Buffett should get the credit he is given.

[Guest Schwab711]

- "Super" company that has not experienced downturn. Most people think that Musk, Page are great managers, but what happens when TSLA, GOOGL go into downturn? Would they be great then? (Both of these examples might be controversial :) ).

 

Tesla IPO'ed during the financial crisis and almost went bankrupt. Musk basically made it survive through sheer will (and putting every cent he had in it, borrowing money to pay rent). That was a much bigger trial by fire than they are likely to get, since at that time they were a small startup selling a few hundred $100k two-seaters during the worst crisis since the 1930s. They're a much more solid company now. Maybe the stock will go down a lot if multiples compress, but the business itself is more solid than its ever been. Saying they've never been through a downturn is incorrect.

 

They have never been through a downturn.

 

Startup pains when you have no product and no sales is very different from a downturn.

 

You might be right though that Elon will deal with downturn just fine based on his startup and other company experiences.

 

The company was founded in 2003. The Roadster was introduced to the public in 2006 and went on sale in 2008. I'd say that the 2008-2009 recession counts as a downturn and not just regular startup pains. They probably would have had lots of startup pains without the 2008-2009 crisis, but with it, they showed incredible resilience. Heck, GM and Chrysler went bankrupt.

 

I think this does a great job pointing out the incredible advantage new companies have in capital intensive businesses (with the BIG if that they can raise capital) vs. the burden legacy companies from the 50's - 70's have from pension obligations! GM/Chrysler would have probably survived without a bailout if not for the outrageous benefits they could not re-define even when it became obvious those benefits would take down the company. This is occurring in small cities (or large ones like Detroit) all over the Northeast

[Liberty]

- "Super" company that has not experienced downturn. Most people think that Musk, Page are great managers, but what happens when TSLA, GOOGL go into downturn? Would they be great then? (Both of these examples might be controversial :) ).

 

Tesla IPO'ed during the financial crisis and almost went bankrupt. Musk basically made it survive through sheer will (and putting every cent he had in it, borrowing money to pay rent). That was a much bigger trial by fire than they are likely to get, since at that time they were a small startup selling a few hundred $100k two-seaters during the worst crisis since the 1930s. They're a much more solid company now. Maybe the stock will go down a lot if multiples compress, but the business itself is more solid than its ever been. Saying they've never been through a downturn is incorrect.

 

They have never been through a downturn.

 

Startup pains when you have no product and no sales is very different from a downturn.

 

You might be right though that Elon will deal with downturn just fine based on his startup and other company experiences.

 

The company was founded in 2003. The Roadster was introduced to the public in 2006 and went on sale in 2008. I'd say that the 2008-2009 recession counts as a downturn and not just regular startup pains. They probably would have had lots of startup pains without the 2008-2009 crisis, but with it, they showed incredible resilience. Heck, GM and Chrysler went bankrupt.

 

I think this does a great job pointing out the incredible advantage new companies have in capital intensive businesses (with the BIG if that they can raise capital) vs. the burden legacy companies from the 50's - 70's have from pension obligations! GM/Chrysler would have probably survived without a bailout if not for the outrageous benefits they could not re-define even when it became obvious those benefits would take down the company. This is occurring in small cities (or large ones like Detroit) all over the Northeast

 

They would also probably have survived if they had been making good products that people wanted to buy at the time. Can't blame it all on one thing...