An Inside Look at Finding Outsider CEOs

"The Outsiders" shows the power of replacing conventional thinking with radical rationality -- and both history and happy shareholders can attest to the massive returns this approach can generate.

May 11, 2014 at 6:30PM

The following article is exclusive content from The Motley Fool. While this is typically paid content, we are bringing it to you free because we think it is especially pertinent to your ability to invest wisely.

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Photo: Brendan Mathews, The Motley Fool

Last August, Motley Fool Stock Advisor published a list of the Top 10 Books for "Today's Well-Read Investor." It's chock-full of good recommendations, mostly from Tom and David Gardner. But in the process of putting together the list, I had the opportunity to highlight a book myself. It was an easy choice -- I recommended The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success by William N. Thorndike Jr. In my opinion, it's easily the best investment or business book published in the past few years, and it's definitely one of my all-time favorites.

It's a favorite of Warren Buffett's, too, and not just because he's profiled in it. This short book chronicles eight CEOs who operated in different industries and dealt with different challenges over the decades but shared the same radical mindset. They set aside the status quo and applied logic and rationality to business with a particular focus on efficient operations and skillful capital allocation. The average returns generated by these CEOs have beaten the S&P 500 by a factor of 20. Buffett's run at Berkshire Hathaway is spotlighted, along with Tom Murphy of Capital Cities, Henry Singleton of Teledyne, Bill Anders of General Dynamics (NYSE:GD), John Malone of TCI, Katharine Graham of The Washington Post, Bill Stiritz of Ralston-Purina, and Dick Smith of General Cinema.

Chess masters as CEOs
Unlike the chief executives who usually capture the public's attention, like Steve Jobs or Elon Musk, the CEOs profiled in The Outsiders weren't visionary entrepreneurs or charismatic leaders. In fact, most shied away from the spotlight and generated awesome returns for shareholders far from the limelight. They weren't star corporate quarterbacks, like Jack Welch of General Electric -- they were chess masters rationally assessing options for generating more shareholder value. In general, they followed a simple formula. Step one, run an efficient operation that generates cash; step two, put that cash to work at high rates of return.

To keep operations efficient, these CEOs generally ran decentralized organizations. Not only does this strategy save on the expense of a bloated staff at headquarters, but it also empowers managers in the field, who typically have more information and expertise than the home office. They avoided high-paid corporate advisors, consultants, and bankers. They structured operations to minimize taxes and maximize cash flow (not accounting earnings).

In considering various uses of the cash generated by their businesses, they were always looking for the highest return possible regardless of the source -- it could be an investment in internal operations, an external acquisition, or a repurchase of company shares. They simply calculated the potential returns for different uses of capital, and they chose the option that would maximize per-share value. If good opportunities weren't available, they would wait -- they were long-term thinkers. But when a great opportunity appeared, they would move quickly and decisively to allocate capital.

The new Outsiders
Of course, the book is a historical study, and most of its profiled CEOs are no longer in business -- Buffett, Malone, and Stiritz being the exceptions. So if we'd like to replicate their outstanding returns today, we need to find a new group with similar characteristics.

Thorndike provides suggestions for finding the next Outsider CEOs. We should look for skilled capital allocators running an efficient operation. Bold moves to improve after-tax shareholder returns, repurchase shares, or maximize cash flow at the expense of earnings are good clues. So are shareholder-aligned compensation policies and a long-term outlook. As an investor, I'm always looking for those kinds of leaders and companies.

But I'm also a fan of very specific answers -- not general suggestions. So I was thrilled when Thorndike visited Fool HQ in Alexandria, Va., as part of his book tour last spring. I enjoyed the speech he gave to the company, and I loved the small lunch that followed, where the Fool's investing group had a free-flowing and candid conversation with Thorndike.

If The Outsiders featured one more CEO, we asked, who would it be? Thorndike said he wanted to write an extra chapter for the book on Ian Cumming and Joe Steinberg of Leucadia National (NYSE:LUK). They have an awesome track record and embody many of the Outsiders' principles, but they also didn't want to be in the book. And without their cooperation, he couldn't write it. (Cumming has since retired, but Steinberg is now Leucadia's chairman of the board.)

We asked which current CEOs fit the Outsiders mold. Thorndike reeled off a short list of names, but he started with Michael Pearson of Valeant Pharmaceuticals (NYSE:VRX). He went on to mention Nicholas Howley of TransDigm Group (NYSE:TDG), and Rich Kinder of Kinder Morgan (NYSE:KMI)

The Foolish bottom line
The Outsiders
 shows the power of replacing conventional thinking with radical rationality -- and both history and happy shareholders can attest to the massive returns this approach can generate.

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Brendan Mathews owns shares of Berkshire Hathaway, Kinder Morgan, and Valeant Pharmaceuticals. The Motley Fool recommends Berkshire Hathaway, Kinder Morgan, TransDigm Group, and Valeant Pharmaceuticals and owns shares of Berkshire Hathaway, General Dynamics, General Electric, Kinder Morgan, and Valeant Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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