I have a family member who believes there is a deep liberal conspiracy to smuggle illegal aliens across the border and dump them with senior citizens. At the same time I have another family member who believes that if it weren't for those pesky conservatives they'd have pristine bridges, commuter rail, free college and whatever else they can dream up. Maybe you can relate to one of these, or maybe like most you are chuckling at the absurdity. The devil is in the details you say. But what's interesting is that often investors will tout equally outlandish theories about companies, and no one bats an eye.
How often have you heard someone say "X company just needs to initiate a buyback" or "Management is a bunch of idiots, anyone could run that failing division" or "we need an activist to unlock value" or "they should sell" or maybe "they should acquire." The list goes on forever. And just like the wild political takes a simple capital markets act will magically make everything better.
Maybe it's just Mr Market that's like this, and you aren't. But I doubt it, every investor does this, myself included. We think that a few simple acts can just change the trajectory of a stock.
But let's step back. Why is a division, company or a stock in a slump in the first place? I look at slumps in stocks/companies (anything?) through a sports analogy. We always love to make fun of last place teams. But those teams with the worst records are made with players who are some of the best in the world. Sure, a few duds might have snuck through, but there are others who have hall of fame fabric. So why does a team do poorly? Do they wake up and say "we want to lose." They all go out and play four quarters like everyone else. How are they so bad?
Companies are the same. Why does a division underperform? Why is a company sub-par? Do employees show up at work and proclaim "I love underperforming today!" Of course not. In many cases employees might be thinking they're doing a great job. They might be exceeding expectations. So what is it?
Most of this stems from our inability as outside investors to appreciate the nuance of a situation. Maybe a division is underperforming because management fails to motivate employees. Different managers who are motivational might be able to turn something underperforming into something outperforming. But we just don't know. Likewise it might seem foolish for a company to be hoarding cash. Why would a company without investment opportunities save money? What we might not know is that management had experience with a nasty downturn and wanted to make sure the company survived going forward.
My point is as outside investors we really don't know or understand the reasons for what's happening. But insiders do. They know why something is dysfunctional, and they know why the problem can't be fixed either.
These simple fixes we toss around as investors aren't new to management. I sometimes laugh when I see activist proposals. I think "I'm sure management has never considered buying back stock, they'll probably be so happy with such a great suggestion." In a few rare cases there are managers who have their heads firmly in the sand. But just like everything else, there is some underlying, and almost guaranteed unspoken reason why the action hasn't happened to date.
Does this mean all hope is lost? Not at all, but we shouldn't hope for simple things either. I could fill an afternoon sharing stories of activists who had a simple fix for a company that turned into a quagmire once they won and became involved. As outsiders we don't know why a situation is what it is, but we should know that fixes aren't simple.
Does this mean we should avoid companies that are a mess? If they aren't trading at a discount for the mess then I'd stay steer clear. Why invest in a mess when you can invest in something pristine for the same price?
What this means is there are no simple fixes for companies, just like lower/higher taxes won't magically fix the nation. The fixes required to unlock value are difficult, time consuming, and costly. But if the discount is deep enough then they're worth it.
I've definitely heard those sorts of thoughts before from outsiders. While it is entirely possible for those ideas to be true, it isn't like the board and management make decisions in a vacuum and there are a lot of factors that outsiders may not consider. As you have said a few times, the act of investing and the act of running a business are two very different things.
ReplyDeleteThis topic and how to evaluate management and the board are some things that I've been thinking about a lot lately. I've heard a number of people that evaluate management based upon results. But it is a bit harder to evaluate the board (and to know if they are making the hard calls and questions or if they are yes man that are collecting high paychecks and don't want to rock the boat so that they can continue to collect them).
As an outside investor, I rarely get the chance to talk to management, but do really attempt to take advantage when I can (by attending the annual meetings and asking questions and talking with the board afterword).