Time is precious, don’t waste it talking to management

Good business, able management and an attractive valuation. Conventional wisdom suggests that these 3 factors are the basis of sound investment decisions. Consequently compromising on one of the three is a sure route to poor results.

Or so they say.

For a long time now, I’ve pondered about this holy trinity and its impact in real, practical decisions. I struggled with item number two: “Able management” for two reasons:

1. History suggests that in “strong management versus weak business” situations, the odds favour the perpetuation of the business’ incumbent status. Warren Buffet’s foray into US Air, or more recently, Jean-Marie Messier’s disastrous erosion of market value in the case of Vivendi, bring this concept home in rather clear light.

As Mr. Buffet himself has stated,

"When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

2. Even under the assumption that management might be able to turn businesses with lousy economics into economic wonders, just how does one go about identifying such management ex-ante?. Sure, we all know now about Steve Jobs turning Apple around in the last decade and unlocking enormous value, but how many would have bet on this outcome in 1997?

Were this not enough to discourage spending one’s precious and finite time on investigating management skill, honesty and motivations, there is a much darker truth out there.

Objective research suggests that actual, direct contact with company management is, for the most part, a waste of time. As renowned behavioural finance expert James Montier writes:

“Managers of companies are just as biased as we are and suffer from over-optimism and over-confidence”.

Quarterly surveys conducted by Duke University on a universe of some 500 CFOs of large American companies over a 4-year period (2002-2005), reveals some very interesting traits:

§ When asked about their own company’s growth expectations versus those of the economy as a whole, management, on average, where some 10% more optimistic regarding their own business than that of the broader economy. Statistically this is simply impossible, but that did not stop their rosy forecasts!.

§ On the subject of stock valuation, a remarkable 63% thought their stock was undervalued, and some 32% though their own fairly valued. This leaves a measly 5% of over-valued stocks by their own admittance. Hardly likely!

In practical terms, these opinions, for indeed this is what they are, are about as valuable as those of the conflict-ridden Wall-Street analysts of internet boom era circa. 1999. This latter group, led then by the infamous trio of Jack Grubman, Henry Blodget and Mary Meeker, encouraged a generation of gullible folks to invest in weak companies at nosebleed valuations on the mere basis of their so-called expert research.

Some 10 years later only Miss Meeker remains in the business, with the other two disgraced and banned from the securities industry.

To be clear, I am not claiming that company management, whose frequent investor relations activity, seems closer to cheer-leading than unbiased information dissemination, should suffer the same fate as the former analysts. But, in the interest of good decision making on the part of investors, I unequivocally advocate limiting contact with management to an absolute minimum.

In so doing, valuable time can be freed-up to afford deep arms-length analysis of business economics and unbiased valuation research. As the say in some rather more fashionable circles than the ones covered here:

Less is more.