Who am I backing here: ideal answer
Second essay of series on my most important question. I cover my preferred investment construct here, before getting to less savoury ones in subsequent essays.
This continues from my previous essay, where I explained why this is the most important question for a long-term investor. A few big decisions each year, taken by the person at the very top, disproportionately influence long-term trajectory of any business. Such decisions typically pertain to values, focus, risk, strategic priorities, response to disruptions, M&A, capital allocation or organization. Their handling decides whether a business ends up leader or laggard within its peer group. As this can dramatically impact my compounding over the long run, “who am I backing here” is my make-or-break question. “Who” refers to both the person as well as the context in which that person functions.
I mentioned that the answer to my question takes many forms (e.g. focused owner, diffused owner, misaligned owner, no owner, new owner, manager, renter). Not all of these are good for my professional wellbeing. I’ll now elaborate on some common forms, starting with the most boring answer (ideal construct) in this essay. I’ll get to more fun parts (avoidable constructs) in subsequent essays. Hopefully, it will add up to a framework for assessing different types of business owners, and their implications for a long-term shareholder.
A caveat before diving in. My prism is that of a permanent owner. At the least, I invest with the idea of holding indefinitely, unless something material about the business changes for the worse. What follows is specific to my context and somewhat extreme in how finicky I am about who I back. Most investors operate under more difficult constraints. They cannot afford to shrink their investable universe by too much. ‘How finicky’ is a subjective judgment call linked to personal preferences and institutional constraints. So, I request you to view what follows directionally, not literally. The issues I raise are relevant to any fundamental investor. But answer need not be. As always, answer is the least important part. This is about a way of thinking through an important problem. We can reach different conclusions with the same thought process.
Let’s get to the most preferred answer to my most important question.
1. Ideal answer to ‘Who am I backing here’
My preferred answer is easy: good promoter. I am backing a longstanding trustworthy focused promoter, with a track record that scores well on governance, prudence, and competence. This is effectively the promoter’s only business. There’s meaningful ownership. Even if this promoter didn’t start the business, generational transitions happened with a sense of continuity. This business means everything to promoter, not merely in terms of net-worth, but in terms of (professional) self-worth. Promoter has a long history of treating others fairly. Since such a promoter’s lifelong mission is to strengthen the franchise, promoter’s interests and mine are perfectly aligned. I may not agree with every decision, but I never doubt intent.
(I am deliberately not repeating my spiel around competitive position, ROCE, moat etc. Those are a necessary condition for even considering a business as investable. This discussion exclusively focuses on the person I am backing in an investment decision.)
Each boldfaced word in previous para is worth delving into. Promoter is in singular form. In my experience, there’s one individual who the buck stops at, even when other family members seem involved. In every instance, my answer to “who am I backing here” is an individual’s name, not a family name. Committees or amorphous groups of people aren’t backable. Singular form is important as a clear hierarchy is essential to prevent family dynamics from derailing business. At any point of time, this person feels indispensable. However, over time, generational transitions have been smooth, usually to next-in-line after decadal apprenticeship.
Longstanding is a necessary condition. I have a confession to make. While I can tell whether a business is good, I have no idea why it is so. Neither do I know why one business is good and another isn’t, often in same industry. Establishing causality in messy world is impossible. How much of a company’s success to attribute to promoter is unknowable. All I know is that business performance was exceptional over a long timeframe when a certain set of input variables stayed constant. One key variable was the person in charge (others include managers, approach, brand etc). Others aren’t independent variables, as they flow out of promoter’s mindset. That’s why seemingly impressive managers often fail when transplanted under a different promoter. When I judge a business to be sustainably good, I am implicitly assuming persistence of input variables that made it good to begin with. So, a longstanding, continuing promoter is central to my conviction around a business staying good.
Trustworthy matters but is to be correctly defined. Investors loosely use the phrase ‘clean’ in a setting where any of us who ever registered a Leave & License agreement is perforce unclean. This isn’t about inevitable ‘costs’ of doing business. I view trustworthy as comprising two aspects. First, a business that has been built in a fair manner, whose advantages stem from capabilities, not cronyism. Second, a history of behaving well with other stakeholders, especially minority shareholders.
Focus is an underrated variable. In general, someone with a track record of sound judgment should continue to demonstrate the same. However, while people don’t change, context can. The contextual change that has done maximum damage is distractions. Promoters need an uncluttered mind to fully engage on each of the big decisions. Other business interests, large acquisitions or any misadventure that entails constant fire-fighting interfere with clear thinking. With distracted decision-making, a crisis can become a calamity. Even outside of crises, being proactive about strategic priorities requires undiluted focus. My business is entirely about getting a few big decisions right. I can only achieve this by sticking to a narrow domain and constantly obsessing about “what am I missing”. Whether investor or promoter, sharp focus is essential for sustained excellence.
These are some of the tenets of my utopian construct. Ideally, I would want a focused, trustworthy, longstanding promoter with a strong track record, across actions and outcomes, 100% of the time. My actual hit-rate is short of 100%, but not by much. This, more than anything else, has led to good things happening, including sound sleep.