Originally published December 11, 2016
I've been giving a lot of thought to the ingredients that make up a successful investment. I'm convinced that backing successful owner operators is one of those ingredients.
With so many businesses to choose from in the equity markets to drive total returns, I've often wondered how you identify those businesses that are most likely to be successful.
Obviously strong moats, good competitive advantages and tailwinds are all elements of what help to drive good growth and sustained profitability over a long time. Additionally the ability to earn strong returns on invested capital is also a necessary ingredient to a successful long-term investment in my book.
However, one of the other factors that I think is overlooked by many people is the existence of an owner operator/ founder. Now owner operator founders tend to be very rare at the helm of the business, certainly as a business gains size and scale.
That's largely because as a business scales, the challenges in running and managing a business tend to be more operational in nature, which requires a different set of management skills to manage through.
While in the early days vision and strategic drive tend to be the key imperatives to be able to grow a business, as a business matures the ability to successfully hire additional managers to put in place appropriate governance structures and launch international operations tend to be more important attributes that almost always leads to a temptation of wanting to find successful career managers to manage through the growth pains of the businesses trying to scale.
Having said that, owner operators can be a very important part of a business that is in a sector going through tremendous change. I think of many of the businesses in the technology sector as ones that benefit from an owner operator founder as the person in charge.
Owner operators know what really made their business successful. They also have a vision for how the industry is evolving and are able to make the right bets and typically see things that career managers just can't see and anticipate.
The other thing I like about seeing founders as owner operators of the business is that they typically have large equity stakes tied into the businesses success. This isn't the token level of options and restricted stock units that career oriented CEOs typically receive.
It's a far more meaningful amount that means their incentives are often more directionally aligned with those of shareholders. This is really important because it helps solve the agency problem.
Career CEOs generally tend to not be as good with strategic vision and direction setting for one thing. However, as agents for the company, they tend to be more often interested in their own career advancement and lining their own pockets.
This often leads to wasteful egregious acquisitions or other actions that are taken to ensure that they hit their performance numbers and near-term bonus metrics rather than being focused on growing long term.
Career CEOs tend to know that once they've exhausted their five-year terms, they are out and have no further involvement with the business. Founder operators tend to have a lot more personal equity tied up such that even if their time as CEO ends, they still remain very significantly invested in the business.
So, where examples of successful owner operator founders and what are their track records like? Well, one doesn't have to look much further than the technology sector to see many examples of this phenomenon.
Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL) and Netflix (NASDAQ:NFLX) all help illustrate this phenomenon really well. Outside the technology sector, I look at examples of companies such as Under Armour (NYSE:UAA) Starbucks (NASDAQ:SBUX) and Nike (NYSE:NKE) as examples that show the tremendous value creation that can be derived by having an owner operator found her running the show for an extended period of time.
I am more inclined to give owner operator CEOs the benefit of the doubt with respect to new missteps or less-than-favorable performance updates because of the fact that they do have a vision they tend to be singularly obsessed with the long-term success of their business and their time frame for their actions tends to be measured in decades as opposed to quarters.
For a long-term investor, that tends to be a really good mindset for successful long-term value creation. You really don't want a CEO who is more fixated on meeting the Street's numbers and objectives for the next quarter or the next year if there's an opportunity to dominate an industry, which means essentially sacrificing some near-term profits.
That should be a recipe for long-term value creation. Owner operator founders also tend to be quite good at capital allocation because they have a more innate sense of market opportunities and where strategic value is likely to be created.
I look for instance at the vision of Jeff Bezos and Amazon. This truly is one of the great companies that I've admired for a long time in terms of vision and execution. Sure Amazon has many detractors who claim that the company can't turn over profit but why should Bezos be focused on near-term profitability if he has the opportunity to dominate retail market share for then for the next 15 years.
I also love the strategic move of the creation of the AWS business from having excess computer capacity, which is surplus to Amazon's own e-commerce needs. Bezos is creating a billion-dollar business literally from nothing. I'm happy to give him the benefit of the doubt with respect to investment of surplus capital rather than looking for him to take actions that are designed for near-term profitability given that the window for success is such a long time one.
Under Armour is another example of a founder CEO that I believe shows the value of sticking with people who have an innate feel for the company and industry they operate in because of their unique insights and passion. Kevin Plank and Under Armour have come under quite a bit of stress and scrutiny over the last couple of quarters because margins and profitability have missed the Street's quarterly estimates.
However, why Kevin Plank should be myopically focused on next quarter's numbers when he has an ability to play the long game, strive for additional market share in global markets and then turn on the profitability screws later on.
Under Armour is still a little brother to global players like Nike and Adidas (OTCQX:ADDYY). The company should be focused on improving brand recognition and taking market share away from industry leaders and acquiring lifelong customers rather than trying to optimize pricing and promotions and meet arbitrary near-term margin targets.
I think Kevin Plank has made many astute moves at Under Armour not least of which is acquiring several connected wellness platforms that allow users to manage their fitness data.
Eventually, these platforms will be seamlessly integrated with Under Armour clothing and footwear. Customers' recommendations can be made to users on a real-time basis to suggest to them the right apparel and the right clothing to meet their fitness goals.
These platforms will also have a bunch of fitness fanatics whose recommendations and influence will go a long way with other users than advertising. If Under Armour is confident in the quality of the product that they deliver, the acquisition of these platforms makes complete sense in the long term to distribute apparel and fitness merchandise.
Owner operator founders who have significant wealth that continues to be invested in the businesses that they founded make for very good investment choices for long-term investor. Riding the strategic vision and direction of these visionaries can be a pathway to long-term success. Investors who are looking for growth in particular are well advised to find these types of businesses and stay on for the long haul.