Book Review: The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success

In his most recent annual letter to shareholders, Warren Buffett recommended several books.  I picked up one of his suggestions earlier this month, and thought it was worth a mention.

Written by William Thorndike, The Outsiders goes through a variety of case studies of highly successful companies whose managements excelled at something that is often overlooked when evaluating companies: capital management.

Thorndike points out that managements have little control over how the market values their stock. He notes that former General Electric chairman Jack Welch is usually cited as one of the top CEO's in recent history, yet Welch's reputation was significantly helped by the fact that his tenure coincided with the greatest bull market in American history (1982 - 1999).

When Jack Welch retired in 2000, the shares of GE were valued at a P/E of 50x, which was a premium to the market at that time.  However, Welch's predecessor Reginald Jones had actually produced better per share earnings growth, but because stocks carried such low multiples throughout much of his tenure Jones never achieved the notoriety as Welch did.

Thorndike makes a thorough examination of eight different management teams who excelled at capital management.

Besides Buffett, included in this group were Tom Murphy at Capital Cities Broadcasting; Henry Singleton at Teledyne; Bill Anders at General Dynamics; John Malone at TCI; Katharine Graham at the Washington Post; Bill Stiritz at Ralston Purina; and Dick Smith at General Cinema.

Good capital management is deceptively simple.  Thorndike writes that CEO's really only need to do two things to be successful: "run their operations efficiently and deploy the cash generated by those operations".  The latter can be hugely important in the success or failure of any company, since large and expensive mistakes can be fatal to a company's existence.

The CEO's of the eight companies he profiles were fixated on growing per share value. If their stock was trading at a cheap enough level in the public markets, they would not hesitate to aggressively buy back shares (over the course of his career  Henry Singleton bought back 90% of Teledyne's shares).  They were relentlessly focused on costs, and kept corporate overhead to an absolute minimum.

At the same time, if a business segment offered promise, they would hesitate to invest significant capital.  The book mentions that Tom Murphy of Capital Cities:

...did not simply cut its way to high margins, however. It also emphasized investing in its businesses for long term growth. Murphy and {CFO} Burke realized that the key drivers of profitability in most of their businesses were revenue growth and advertising market share, and were prepared to invest in their properties to ensure leadership in local markets.

Throughout the book Thorndike notes that successful capital allocators are prepared to think in a fashion considerably different than most of their peers, and were often considered outsiders.  Most CEO's focus on earnings per share, but this group focused instead on cash flow:

As a result, the outsiders (who often had complicated balance sheets, active acquisition programs, and high debt levels) believed the key to long-term value creation was to optimize free cash flow, and this emphasis on cash informed all aspects of how they ran their companies - from the way they paid for acquisitions and managed their balance sheets to their accounting policies and compensation systems.

Finally, Thorndike describes that the fabulous success that all of his studies achieved had several characteristics in common:

Each ran a highly decentralized organization; made at least one very large acquisition; developed unusual, cash flow-based metric; and bought back a significant amount of stock. None paid meaningful dividends or provided Wall Street guidance.  All received the same combination of derision, wonder and skepticism from their peers and business press. All also enjoyed eye-popping, credulity-straining performance over very long tenures (twenty-plus years on average).

I found this book a terrific read, and well worth any serious investor's time.

Betting on the Blind Side Business: vanityfair.com

Michael Lewis has a new book out entitled The Big Short.

Most of us in the financial services business have been reading Michael Lewis for years.

Starting with Liars Poker, his very entertaining account of his short career as a bond salesman at Salomon Brothers (now part of Citigroup), Lewis has a gift for making difficult and often arcane financial subjects seem interesting.

Lewis has been everywhere in the media recently - "60 Minutes", "Charlie Rose", etc. and even last weekend on PBS's "Wait, Wait, Don't Tell Me". Clearly his publishers and he have high hopes for this book, and have arranged this massive media campaign.

For some reason known only to Lewis and his agent, they have decided to not release a version on Kindle - not yet, at least - which means that I probably will not be reading the book anytime soon.

Interestingly, some of my fellow Kindle lovers are waging a negative campaign on Amazon with the hope of forcing the publishers hand and getting the book on Kindle.

If you go to Amazon, you will see the composite rating of The Big Short is "three stars", which essentially means "average". However, if you read the reviews of the people who have actually bought the hardcover copy, they are all glowing - "five star". These reviews have been essentially negated by a host of "one star" reviews posted by angry Kindle owners.

I draw two lessons from this: first, you can't trust composite ratings; and, second, beware the power of on-line reviewers!

In any event, here's an excerpt from the book, courtesy of Vanity Fair:


Betting on the Blind Side Business: vanityfair.com

Good Investment Books

Occasionally I'll get asked if I know of any good books to read on investing.

There are literally hundreds published each year, of course, and deciding which one is worth reading is always a challenge.

However, here's a few that I have on my shelf at home, and may be useful for others as well.

As I put together this list, I was struck by the fact that most of these books have been out for some time.

Some of this, of course, could simply be a reflection of my age, but I also think it indicates that I tend to go for books that have proven the test of time. Too many investment books, in my opinion, tend towards the "get rich quick" approach which I don't really favor.

I'm sure I'll miss a few, but here are some that I have found useful over the years.

I have listed these in no particular order, by the way.

General Investing:

• The Only Investment Guide You'll Ever Need - Andrew Tobias
• Common Stocks, Uncommon Profits - Philip Fisher
• Reminiscences of a Stock Operator - Edwin LeFevre
• One Up on Wall Street - Peter Lynch
• The Money Game - "Adam Smith"
• A Random Walk Down Wall Street - Burton Malkiel
• The Intelligent Investor - Benjamin Graham
  

Good Historical Perspective:

• Buffett: The Making of an American Capitalist - Roger Lowenstein
• When Genius Failed: The Rise and Fall of Long-Term Capital Management - Roger Lowenstein
• Irrational Exuberence - Robert Shiller
• Paper Money - "Adam Smith"
  

More Specialized Books:

• Technical Analysis of the Futures Market - John Murphy
• Valuing a Stock - Gary Gray, Patrick Cusatis, Randall Woolridge
• Inside the Yield Book - Sidney Homer and Martin Leibowitz
• Options As a Strategic Investment - Lawrence McMillan

Miscellaneous:

• Who Says Elephants Can't Dance - Louis Gerstner, Jr.
• The Smartest Guys in the Room - Bethany McLean and Peter Elkind
• Beat the Dealer - Edward Thorp
  

And, of course, just reading Warren Buffett's annual letters (www.berkshirehathaway.com) can be an education in itself!

Book Review: "Outliers" by Malcolm Gladwell

This book has been very popular - I noticed this morning that it has been on the New York Times bestselling list for 64 weeks.

It's a quick read. Mr. Gladwell writes for The New Yorker, and to me the book had the feel of a long magazine article.

That said, it was very interesting, and I found myself thinking about some of his observations long after I had finished reading.

For example, Gladwell notes that intelligence is an overrated aspect of success. In fact, he makes the persuasive argument that once a certain IQ level is reached intelligence becomes almost irrelevant. He even suggests (somewhat tongue-in-cheek) that admissions to prestigious schools like Harvard become more like a lottery: all applicants who have demonstrated a certain intelligence level would be thrown into a drawing, with students drawn at random.

Persistence, however, is a quality that nearly all successful people seem to share. Gladwell suggests a "10,000 hour" rule: if one is to become truly outstanding at a particular endeavor, a minimum of 10,000 hours of practice, study and hard work seem to be necessary. This is fairly daunting, once you think about it: if you were a musician who practiced 3 hours a day, 7 days a week, this would imply about 1,100 hours of study a year. According to this rule, then, one would need to spend at least 10 years of intensive study to become truly proficient at a given endeavor.

Gladwell spends a lot of time on different cultures, and the various ways that societies around the globe interact. He has a number of pages studying Korean culture, and the possible ways that the hierarchical way that Korean society interacts may have contributed to at least one Korean airliner crash. On the other hand, Asian cultures have tended to produce more than their fair share of exceptional math and science students, and Gladwell believes that this too is the result of cultural influences rather than innate intelligence.

I'm not a sociologist, so I have no way of judging whether some of his conclusions can stand up to close scrutiny, but most of the book rang true to me.