“ . . . our whole attitude in [Berkshire
Hathaway] and what we like to see with the businesses we own stock in is we
want to run them for the people who are going to stay in rather than the people
who are going to get out. “ –
Warren Buffett
______________________________
Whenever a
lean blog publishes a post on the subject of shareholders, it’s usually focused
on the negative effects that they can have on a company’s long-term
performance. This one is going to be
different. Reading Warren Buffet’s 2014
letter to Berkshire-Hathaway shareholders reminded me of the important role
shareholders play in a company’s success and wonder what business would be like
if all investors approached business the way he does.
Investing 101
Investors
are a critical part of the operation and growth of a company. Financing all investment opportunities with
debt would be cost prohibitive, and result in stunting growth or sinking the
company altogether if interest payments became due before revenue streams from
the investments began to occur. Since
interest payments provide the bank’s revenue stream that supports its operation,
it needs to be as predictable as sales of products are to a manufacturing or
distribution company – which is why shareholders came into the picture. In the most basic sense, banks finance an
organization’s short-term needs while investors finance long-term growth. Investors who have a “day job” generally rely
on salary or wages to finance their day-to-day lives (i.e., their operation) and
use investments to finance long-term needs.
Investors without a regular job usually buy stocks that provide little
growth but stable income in the form of dividends. [Note
to Finance Professionals . . . this is very basic, so please just go with it]
A
combination of the immense growth in stock prices over the years and the
instant gratification society in which we live has led many shareholders to begin
to act like banks and demand short-term returns for their long-term investments. As a result, the balance between short-term
and long-term performance has been upset.
In an effort to keep up with the demands of shareholders (and continue
to efficiently finance growth), decisions are sometimes made that can actually damage
the company’s long-term success (e.g., mass layoffs or curtailing needed
investment). Focus and energy are
steered toward satisfying the needs of shareholders rather than customers and
the death spiral begins (although the effects may not become evident for many
years). In an effort to assure that the
value of a company remains high boards started basing executive bonuses on
share price. As a result, some
executives ended up losing sight of the true target condition – lower the
overall cost to finance long-term growth – and focused only on the share price
by taking action that increases the short-term stock value while actually
hurting the long-term. Imagine how different
things would be today if, decades ago, companies like IBM, Exxon, or Boeing
focused more on short-term performance than long-term development and growth.
To survive and grow,
companies must continually build new factories and develop new products,
processes, or services. And, although
the leadtime for new developments has dropped, it still takes time to do it successfully. Developing a new car model or explore and
develop a deepwater oil field can take years and cost billions of dollars and,
even though the payback may not be seen for many years, it is a necessary investment
to assure an ongoing revenue stream.
Are We Are Part of the Problem?
Not surprisingly, I’ve
met many people over the years who complained about decisions and actions taken
by their employers because they appeared to focus more on the short-term share
price than the long-term growth and overall health. It is surprising, though, that many of these same
people check the share prices of the stocks they own several times a day, and
buy and sell stocks throughout the year in response to rising and falling
prices. It is easy to get disappointed
when the value of a stock we own drops, just as it is to get excited when it
rises. As an example, after making
resounding returns on Google stock, many people sold their shares in July of
2011 when the price dropped 20% within one month. I wonder how many of these same people
realize that, had they held on to their shares and thought more about the ongoing
earnings and long-term growth potential of the company than the short-term
share price, their investment would have increased more than 120% since that
time.
We would all like
the share prices of the stocks we own to increase every day, indefinitely. This is not possible, though, so we have to invest
in companies that have a high likelihood of increasing over the long-term –
i.e., have a clear vision, high quality leaders, a believable estimate of
future earnings, and demonstration of the ability to continually improve. Once these things become evident and we make
the investment, we need to get out of the way and let the company operate. Over the last several years, following this
type of philosophy would have led to the decision to invest in companies like
Google, Amazon, Tesla . . . oh, and Berkshire-Hathaway.
The Shareholder Activist
In recent years, the
activist investors have taken a much more prominent role in the business
world. In some instances where activists
successfully shook up the company, the result has been positive while in others
it has been disastrous. I believe it
comes down to a question of motives.
Those who have already invested in the company and, in an effort to
protect their investment by stopping an ineffective management team from damaging
the company often result in positive change and long-term growth. On the other hand, those who are short-term
investors or are on an ego trip can cause considerable destruction to its
employees and its longer-term shareholders.
In either case, though, the battle between the activist and company
leaders creates an ugly and stressful situation for everyone involved.
Advice from the Oracle
It continually
amazes me how so many tend to ignore the advice of Warren Buffett who is
arguably the best investor of our time, and instead follow the high-profile
activist investors. While we all respect
Buffett and can’t wait to learn about his next investment, though, we continue
to look at share prices daily and sell shares when prices fall over a given
period of time. His comment in the
letter about his farm sums up the fallacy of this approach:
“. . . if a moody
fellow with a farm bordering my property yelled out a price every day to me at
which he would either buy my farm or sell me his -- and those prices varied
widely over short periods of time depending on his mental state -- how in the
world could I be other than benefited by his erratic behavior? If his daily
shout-out was ridiculously low, and I had some spare cash, I would buy his
farm. If the number he yelled was absurdly high, I could either sell to him or
just go on farming.”
We don’t expect the
companies to act this way with markets and offerings, so why do we think it’s
okay to do it with our investments? The
people who sold Google stock in 2011 reacted to the neighbor yelling a lower
and lower price every day, even though the company had a strong revenue stream
and many new products in the pipeline that would allow that revenue to continue
to grow. Many of the people who sold
their shares did so because they did not understand this and feared that the
stock was overvalued.
Where We Are
It would be great
for companies – particularly well-managed ones – if all investors followed
Buffett’s investment strategy. Effective
leaders could focus on what’s best for the long-term and build strong, healthy
companies without worry of distractions from shareholders focusing on quick
gains. Since this is not – and likely never
will be – the case, we’ve got to learn to live with the demands of
investors. They are, after all, important
stakeholders in the business and their needs cannot be ignored.
Taking care of
shareholders, though, does not mean focusing on short-term actions that do
nothing but increase share price. It
means focusing on the customer, developing new products and services that continually
take care of customer needs, and doing it safely, quickly, and
efficiently. We need to partner with
shareholders in a way that everyone wins.
Warren Buffett has done this by being very open about his focus and
making it clear that Berkshire Hathaway is not a company for the short-term
investor. To be successful with this
approach, however, requires effective leadership, clarity and constancy of
purpose, and the ability to deliver as promised. And even though adjustments will be required
during downturns or when things do not go as planned, leaders must never make
decisions or take actions that stray from the purpose. They must keep investors updated on the
outlook and planned adjustments (including the reasons for the adjustments),
and respect the fact that they are partners in the business and have a stake in
its success.
Interesting that it still
comes down to effective leadership . . . something that companies like Amazon,
Toyota, Google, and Berkshire Hathaway remind us every day.
