Tuesday, May 12, 2015

Considering Management's "Capacity to Suffer"

Earlier this week, Brattle St. Capital shared an interview transcript (originally posted on ValueWalk) with noted investor Tom Russo in which Russo discussed the importance of investing in companies with management teams that have the "capacity to suffer":
When management makes those investments, they must have the capacity to suffer. They have to suffer during the start-up period of those investments because they are not necessarily linked to at the hip with the Wall Street expectations of smooth and steady quarters, but they are able to withstand the burden of the investment cycle. It is inevitably certain that profits are low or non-existent during these early years. And if you do not have the capacity to suffer through that period, you will shy away from making the accurate amount of investment. Your management will under-invest at a time when they have set an advantage and will allow competitors to come into the market. 
This is an important point to consider. Can management make the necessary, long-term investments in its business that support or widen its moat without taking on significant career risk in the process?

Even if we're talking about an otherwise-strong business, it's not a recipe for long-term success if the CEO is overly-concerned about how a value-accretive investment will impact earnings per share in the current quarter or calendar year and how Wall Street may react to temporary weakness.

Put another way, if you're a patient investor in a company that's led by an impatient management team, be prepared for an unpleasant outcome.

To remedy this, Russo recommends looking for family-owned businesses that can afford to ignore the short-term obsession of the street and activist investors.

When researching a new idea that isn't family-owned, I also look through the list of the company's major shareholders - these are usually mutual funds and institutions.

Once you have the list of major owners, take a look at each fund's website to learn more about their philosophy and approach. Are they also long-term focused or do they have high portfolio turnover? How long have they held the stock in question?

The more the company is owned by investors who "get it," the less pressure management will likely feel to deliver short-term results at the expense of long-term value creation.

Related posts:
Stay patient, stay focused.