What follows mostly applies to growth stocks.

In the case of value stocks, which are asset-rich but somehow not able to generate profits, we are betting by owning them that change will happen. In a sense, we are holding a stock despite/because of current management’s inability to employ those assets effectively. We’re waiting/hoping for a catalyst that will unlock this value. Maybe we’re hoping for change of heart; a change in control is more likely, though.

on the plus side: reinvention

The rule of thumb that I’ve used for a long time is that a growth stock typically has a shelf life of about five years of doing the thing that makes it attractive for investors today. To hold it for a longer time, we’ve got to believe that the company can reinvent itself on the fly.

Walmart is a classic example.

It started out by building variety stores at the edge of small towns, undercutting local merchants on price. As it started to run out of new small towns to enter, it expanded into Mexico (a great move) and the UK and Japan (pretty awful). Then it entered the warehouse club market with Sam’s Club. When these arms began to mature, it added groceries, to compete directly against supermarkets.

Then for years it did a bunch of nothing–and, to my mind, became much less interesting as a stock.

Now it seems to me to be trying to transform itself once more, becoming a direct competitor to Amazon as an online merchant. Another potential plus: as WMT grew into a national company, political opposition by incumbent businesses kept it out of California, and lack of available land limited its scope for building its superstores in the Northeast. In a post-pandemic, work-at-home world, this might actually be a benefit.

on the negative: the nobody-will-notice paradigm

I find it hard to generalize about weak managements–both individuals and corporate cultures–other than that they tend to reveal themselves in lack of care about shareholders, the ultimate owners of any publicly-traded company. I suppose this is more a family resemblance thing than a single characteristic common to all bad managers.

two common situations

–Imagine you’ve just become the CEO of a major company, after twenty-some years of intense corporate infighting. You have, say, 3-5 years to cash in in a huge way from bonuses and stock options. You know, going in, the company needs a major retooling to keep it ahead of the competition over the next decade. This will doubtless cause the company to generate losses over the next two years. That will likely put a large hole in your wallet, by lowering the value of your bonuses and stock options. What do you do? The bad solution, but a common one–think, GM, Ford, Chrysler–is to cash in as big as you can and leave the problem for the next CEO to deal with.

–as people become older and wealthier, they become increasingly risk-averse. In a family-controlled company, uncles and aunts, cousins and nieces and nephews of the founders will likely have high-paying jobs there. So making sure this year’s profits is at least equal to last year’s, and not lower, is a much more important objective than making them grow. This is a big reason I find what I see as a more adventurous spirit at WMT so intriguing.

In my experience, however, most of the time it’s been a little thing that triggers my “bad management” reaction. And because it’s a little thing, it’s easily thinkable that I’ll be wrong. On the other hand, it’s a big, wide world, and I’ll be kicking myself around the block if I ignore my instincts. Arguably, too, this “little thing” may just be the trigger that brings to the surface worries I’ve already been having.

examples

–I’ve recently written about Bill Gates saying the most important thing about Microsoft for him was to be able to give jobs to his friends

–in early 2000, I think, the SEC cited both GE and IBM for each having submitted false/misleading financial results for one small division. There was very little immediate stock market reaction. But I was stunned–more for what it said about the corporate culture at these places than anything else

–I remember a debate many years ago at Costco. The company’s financial strategy had been to mark up its products by only enough to cover its costs. All of its profits came from membership fees. A new generation of top managers began to argue that no one would notice if prices were raised by, say, 5%, over a couple of years. The (winning) argument against was threefold: that this was the first step on a slippery slope, that the reputational damage when customers discovered stuff was cheaper elsewhere would be irreparable, and that customers weren’t so stupid that they’d never notice.

–there seems to have been a similar argument at Boeing, that no one would notice a little cost-cutting. But that ballooned into something much bigger and much more harmful. BA has also had a series of former-GE executives as CEO, who seem to have spearheaded the outsourcing.