The Outsiders: Capital Surgeons

William Thorndike’s “Outsiders” has sat on my desk since first reading the book last summer.  Recent market action presented us with an opportunity to refresh our work on The Outsider’s Mindset.  

Thorndike’s Outsiders operated in a “parallel universe” defined by a strict devotion to a shared set of core principles. These CEO’s were not marketing or technical geniuses. They simply understood capital allocation and thought carefully about how to deploy resources and create shareholder value.

Outsiders only moved forward with investments that offered attractive returns using conservative assumptions and had the confidence to do things differently than peers. This is easier said than done. “In many ways the business world is like a high school cafeteria clouded by peer pressure,” Thorndike accurately portrayed.  “Particularly during times of crisis, the natural, instinctive reaction is to engage what behaviorists call social proof and do what your peers are doing. In today’s world of social media, instant messaging and cacophonous cable shows, it’s increasingly difficult to cut through the noise.”

A handful of lessons stand out and serve as a good starting point for evaluating corporate management today:

Always Do The Math.  The Outsiders always started by asking what the return was. Every investment generates a return and the math is just fifth grade arithmetic, but these CEOs did it consistently, used conservative assumptions and only went forward with projects that offered compelling returns. They focused on the key assumptions, did not believe in overly detailed spreadsheets and performed the analysis themselves, not relying on subordinates or advisors. They believed that the value of financial projections was determined by the quality of the assumptions, not by the number of pages in the presentation and many developed succinct, one-page analytical templates that focused on key variables.

The Denominator Matters. These CEOs shared an intense focus on maximizing value per share. To do this, they didn’t simply focus on the numerator. They also focused on managing the denominator through the careful financing of investment projects and opportunistic share repurchases. These repurchases were not made to prop up stock prices or to offset option grants but rather because they offered attractive returns as investments in their own right.

A Feisty Independence. The Outsiders were master delegators, running highly decentralized organizations and pushing operating decisions down to the lowest levels in their organizations. They did not, however, delegate capital allocation decisions. In addition to thinking independently, they were comfortable acting with minimal input from outside advisors.

Charisma Is Overated. The Outsiders were also distinctly unpromotional and spent considerably less time on investor relations than peers. As a group, they were not extroverted or overly charismatic. They did not seek the spotlight. Their returns, however, more than compensated for this introversion.

A Crocodile Like Temperament. Armed with their return calculations, all were willing to wait long periods of time for the right opportunity to emerge. Many created enormous shareholder value by simply avoiding overpriced strategic acquisitions, staying on the sidelines during periods of acquisition feeding frenzy.

With Occasional Bold Action. This penchant for empiricism and analysis did not result in timidity. Just the opposite: on the rare occasions when they found compelling projects, they could act with boldness and blinding speed.

The Consistent Application of a Rational, Analytical Approach to Decisions. These executives were capital surgeons, consistently directing capital toward the highest-returning projects. Over long periods of time, this discipline had an enormous impact on shareholder value through the steady accretion of value-enhancing decisions and the avoidance of value-destroying ones. This unorthodox mindset proved to be a substantial and sustainable advantage for their companies – cutting through the glare of peer activity and conventional wisdom to see the core economic reality and make decisions accordingly. These CEOs knew precisely what they were looking for – they didn’t overanalyze or overmodel and they didn’t look to outside consultants or bankers to confirm their thinking – they pounced.

A Long Term Perspective. Although frugal by nature, The Outsiders were also willing to invest in their businesses to build long-term value. To do this, they needed to ignore the quarterly earnings treadmill and tune out Wall Street analysts and the cacophony of cable shows like Squawk Box and Mad Money, with their relentless emphasis on short-term thinking. This perspective often leads to contrarian behavior.