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October 26 - November 4, 2020
CEOs need to do two things well to be successful: run their operations efficiently and deploy the cash generated by those operations.
Basically, CEOs have five essential choices for deploying capital—investing in existing operations, acquiring other businesses, issuing dividends, paying down debt, or repurchasing stock—and three alternatives for raising it—tapping internal cash flow, issuing debt, or raising equity.
Foxes, however, also have many attractive qualities, including an ability to make connections across fields and to innovate, and the CEOs in this book were definite foxes.
Each ran a highly decentralized organization; made at least one very large acquisition; developed unusual, cash flow–based metrics; and bought back a significant amount of stock. None paid meaningful dividends or provided Wall Street guidance. All received the same combination of derision, wonder, and skepticism from their peers and the business press. All also enjoyed eye-popping, credulity-straining performance over very long tenures (twenty-plus years on average).
“The goal is not to have the longest train, but to arrive at the station first using the least fuel.”
focus on industries with attractive economic characteristics, selectively use leverage to buy occasional large properties, improve operations, pay down debt, and repeat.
Murphy’s approach to the roll-up was different. He moved slowly, developed real operational expertise, and focused on a small number of large acquisitions that he knew to be high-probability bets. Under Murphy, Capital Cities combined excellence in both operations and capital allocation to an unusual degree. As Murphy told me, “The business of business is a lot of little decisions every day mixed up with a few big decisions.”
Murphy turned the station into a consistent cash generator by improving programming and aggressively managing costs,
There are two basic types of resources that any CEO needs to allocate: financial and human.
“Decentralization is the cornerstone of our philosophy. Our goal is to hire the best people we can and give them the responsibility and authority they need to perform their jobs. All decisions are made at the local level. . . . We expect our managers . . . to be forever cost conscious and to recognize and exploit sales potential.”
“hire the best people you can and leave them alone.”
“The company was careful, not just cheap.”
“The system in place corrupts you with so much autonomy and authority that you can’t imagine leaving.”
Like others in this book, he relied on simple but powerful rules in evaluating transactions. For Murphy, that benchmark was a double-digit after-tax return over ten years without leverage.
Singleton and Roberts quickly improved margins and dramatically reduced working capital at Teledyne’s operations, generating significant cash in the process.
As with Anders’s sale of the company’s F-16 business, Chabraja’s equity sale underscores the important point that the best capital allocators are practical, opportunistic, and flexible.
Luck is the residue of design. —Branch Rickey
Managers were expected to hit their cash flow budget, and these targets were enforced with an almost military discipline by Sparkman, a former air force officer.
As a result of this frugality, TCI, for a long time, had the highest margins in the industry and gained a reputation with its investors and lenders as a company that consistently underpromised and overdelivered.
Terms and concepts such as EBITDA (earnings before interest, taxes, depreciation, and amortization) were first introduced into the business lexicon by Malone.
Graham, under Buffett’s tutelage, proved to be a highly effective, if unorthodox, capital allocator.
“Stiritz ran Ralston somewhat akin to an LBO. He was one of the first to see the benefit to shareholders of higher leverage as long as cash flows were strong and predictable . . . He simply got rid of businesses that were cash drains (no matter their provenance) . . . and invested more deeply in existing strong businesses through massive share purchases interspersed with the occasional acquisition that met our return targets.”
“Leadership is analysis.”
Smith, however, realized that a well-located theater could quickly generate predictable cash flow, and he pioneered the use of lease financing to build new theaters, dramatically reducing up-front investment. This innovation allowed Smith to grow General Cinema’s theater circuit rapidly with minimal capital investment.
However, the company did offer equity to key managers through options and a generous stock purchase program in which the company matched employee investments up to a stated maximum level. The net effect of these initiatives, according to Woody Ives, was that the executive team “felt like owners . . . we were all shareholders and behaved as such.”
Smith succeeded in creating an environment where this talented group of executives was given exceptional autonomy and felt like owners.
Buffett had always been interested in the stock market, and at age nineteen read a book called The Intelligent Investor by Benjamin Graham, which was a Paul-to-Damascus-type epiphany for him.
In both insurance and investing, Buffett believes the key to longterm success is “temperament,” a willingness to be “fearful when others are greedy and greedy when they are fearful.”
Whenever Buffett buys a company, he takes immediate control of the cash flow, insisting that excess cash be sent to Omaha for allocation.
“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”
Buffett does not spend significant time on traditional due diligence and arrives at deals with extraordinary speed, often within a few days of first contact. He never visits operating facilities and rarely meets with management before deciding on an acquisition.
He is able to move quickly because he only buys companies in industries he knows well, allowing him to focus quickly on key operating metrics.
The annual reports and meetings reinforce a powerful culture that values frugality, independent thinking, and long-term stewardship.
Buffett has developed a worldview that at its core emphasizes the development of long-term relationships with excellent people and businesses and the avoidance of unnecessary turnover, which can interrupt the powerful chain of economic compounding that is the essence of long-term value creation.
To Buffett and Munger, there is a compelling, Zen-like logic in choosing to associate with the best and in avoiding unnecessary change. Not only is it a path to exceptional economic returns, it is a more balanced way to lead a life; and among the many lessons they have to teach, the power of these long-term relationships may be the most important.
The outsider CEOs were also distinctly unpromotional and spent considerably less time on investor relations than their peers.
“relentless focus on returns at the expense of ego.”
Although frugal by nature, the outsider CEOs were also willing to invest in their businesses to build long-term value.
they disdained dividends, made disciplined (occasionally large) acquisitions, used leverage selectively, bought back a lot of stock, minimized taxes, ran decentralized organizations, and focused on cash flow over reported net income.
Again, what matters is how you play the hand you’re dealt, and these executives were dealt very different hands.
There is no strict formula here, no hard-and-fast rules—it does not always make sense to repurchase your own stock or to make acquisitions or to sit on the sidelines.
As a group, these CEOs faced the inherent uncertainty of the business world with a patient, rational, pragmatic opportunism, not a detailed set of strategic plans.
They had the perspective of the long-term investor or owner, not the high-paid employee—a very different hat than most CEOs wear to work.
