In his book The Outsiders, William Thorndike explores the journey of eight unconventional CEOs that achieved extraordinary returns for shareholders during their tenure.
- Berkshire Hathaway’s Warren Buffett
- Capital Cities Communications’ Thomas Murphy
- General Cinema Corporation’s Richard Smith
- General Dynamics’ Bill Anders
- Ralston Purina’s Bill Stiritz
- Tele-Communications Inc.’s John Malone
- Teledyne’s Henry Earl Singleton
- The Washington Post’s Katharine Graham
Thorndike’s research found each executive to share common characteristics. This included their affinity for effective capital allocation and their focus on long term value creation on a per share basis. In his book, Thorndike presents their rational blueprint for capital allocation, which we review briefly in this post.
A rational blueprint for capital allocation
Each of these unconventional CEOs were first-time CEOs with limited managerial experience. Their primary focus was on capital allocation, taking a long term orientation to business decisions and improving long-term value per share. Thorndike highlights that they were each analytical, frugal, humble and independent by nature. By contrast, most of their peers were very experienced managers and CEOs. Their primary focus was on operations management, external relations and company growth. They were typically charismatic and extroverted in personality.
Thorndike suggests that these differences in personality and management style helped each of the outsiders to achieve outstanding long-run success. He highlights that these eight CEOs also shared a common but rational blueprint for effective capital allocation, discussed briefly as follows.
Always do the math
Each CEO always started by asking what the return was on investment opportunities. They focused on key assumptions and relied on conservative parameters. They did not rely on detailed spreadsheets and analysed major opportunities themselves (as opposed to relying on subordinates, advisers or consultants).
The denominator matters
The focus is always on maximising value per share (not just total company value). They were careful with how they financed investment projects, opportunistic with share repurchases and avoided overpaying for acquisitions and capital projects.
Feisty independence
Each CEO ran decentralised operations but centralised capital allocation activities. They were great delegators but took responsibility for all major capital allocation decisions. They were comfortable to act without input from outside advisers, diverge from peers and ignore institutional imperative.
Charisma is overrated
Unlike traditional CEOs, they were non-promotional and spent less time on on investor relations. They did not provide earning guidance or participate in Wall Street conferences. They also possessed a great deal of humility.
A crocodile-like temperament
These executives combined patience with occasional boldness. They were comfortable with waiting long periods of time without action until the right opportunity arrived. On the rare occasions that attractive investment opportunities presented itself, they would act with boldness and speed. They also created value by avoiding overpriced acquisition, preferring to stay on the sidelines during periods of irrational exuberance.
Rational and long term thinking
Each CEO applied a rational and analytical approach consistently and to all decisions, whether large or small. They were pragmatic, analytical and disciplined, and encouraged frugality within the company’s culture. Furthermore, they always took the long run view and ignored quarterly earnings and Wall Street’s obsession with short term commentary. Finally, they were unafraid to act contrarian when required (and not simply for the sake of it).
The Outsiders’ checklist for capital allocation
Inspired by the principles, methods and long term success of these eight outsiders, William Thorndike presented a simple checklist for more effective capital allocation. We include some of the key ideas as follows:
- Your CEO should lead the process for capital allocation. It should not be delegated to business development or finance personnel.
- Determine your hurdle rate. This is the minimum acceptable return for investment projects. It should be in reference to a set of opportunities available to the company. It should exceed the blended cost of equity and debt.
- Calculate the expected returns on all internal and external investment alternatives. Rank them by return and risk. While these estimates do not need to be precise, they should impose conservative assumptions. Higher risk require higher expected returns.
- Calculate the return for stock repurchases. Returns from acquisitions must exceed this benchmark. Repurchases can destroy value if prices are exorbitant.
- Focus on after-tax returns and run all transactions by your tax counsel.
- Determine the acceptable levels for debt and cash. Run your company within this conservative range.
- Consider a decentralised organisational model. This is the ratio of corporate to total employees relative to your peer group average.
- Retain capital in the business when you have confidence that you can generate returns that exceed your hurdle rate over time.
- Consider paying a dividend when you do not have high return investment projects. Dividend decisions can be hard to reverse and sometimes tax inefficient.
- When company prices are high, it is okay to consider selling your business, divisions and/or stock. It is also okay to close-under performing business units when they can no longer generate returns at acceptable levels.
References
Thorndike, W. (2012). The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success.
Green, S. (2014). How Unusual CEOs Drive Value. Interview with William Thorndike. Harvard Business Review. Available at < https://hbr.org/2014/04/how-unusual-ceos-drive-value >