At The Motley Fool, we take an unconventional approach to evaluating stocks. While "professional" analysts are dissecting quarterly profit margins, we're digging into intangible leadership qualities that can allow us to crush Wall Street in the long run.
These are things we can do that Wall Street often can't. And Will Thorndike, a private equity manager with a long-term perspective, believes it gives us a crucial advantage.
Thorndike wrote a groundbreaking book on this very topic recently called The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. The book identifies outlier CEOs that dominated their industry and beat the market at-large for decades on end. Motley Fool CEO Tom Gardner recently sat down with Thorndike to talk about the traits of extraordinary CEOs. You can watch and read their fascinating discussion at your leisure.
You can also apply Thorndike's insights to companies in your portfolio. Since I found General Electric to be a highly relevant test case, I decided to dissect GE's CEO Jeff Immelt on three traits of an "outsider" executive. Here is what I found.
1. Outsider CEOs outperform their peer group dramatically over their tenure.
Thorndike's research shows that the "outsider" CEOs operate unconventionally in their industry. In the face of adversity, these leaders remain calm and collected, which allows them to beat their peers -- dramatically, in fact -- on a level playing field.
For Jeff Immelt and GE, adversity struck almost immediately after he assumed the role of CEO on Sept. 7, 2001. It was less than a week before 9/11, a tumultuous period for any company in America. Legendary CEO Jack Welch was on the way out, and Immelt had huge shoes to fill.
Despite the challenge, this period provided a lesson that would serve him well over the decade to come: The world is unpredictable, and we live in what he refers to as a "new normal" era of volatility. With this in mind, let's look at how GE performed relative to its competitors.
Instead of using a broad index for comparison, I isolated five industrial companies I believe measure up well against GE in terms of business lines, size, and markets served. These American companies include 3M, Danaher, United Technologies, and Honeywell. I also included Germany's Siemens since it is truly GE's European counterpart. Here are the total stock returns for all six from 2001 to the present day:
As you can see, GE has underperformed its closest peers over roughly a dozen years, even including dividends. Quite improbably, however, these stocks moved in a near lockstep over this timeframe. Not a single company really broke away from the pack, which I found surprising even given their "bellwether" status.
In this context, Immelt does not measure up as an "outsider" CEO, but then again neither do his rival executives. It's an interesting timeframe given the start date around 9/11, but still well beyond Thorndike's rule-of-thumb that allows for 2 to 3 years for at the helm for a new CEO.
2. Outsider CEOs are phenomenal at managing cash.
CEOs are known for running businesses, specifically for being excellent operators and innovators. Less often, however, are they lauded for managing shareholder capital in the most optimal manner. But, from Thorndike's perspective, cash management is frequently a key indicator of success.
I believe we ignore this category because it carries less cachet than the aforementioned areas and because, frankly, it's difficult. Regarding the latter, I can't line up several similar companies and compare apples-to-apples how one CEO did relative to another in terms of cash management. It's situation-specific. Further, there are five distinct methods a leader can use to deploy cash or capital, and all these levers mean it's a complicated analysis to undertake.
For our purposes, I'll list the five levers a CEO can pull and provide commentary on GE's above-par or below-par strategy relative to Thorndike's conclusions.
You can use capital at a company to do the following:
- Make acquisitions: Thorndike says great leaders strike quickly when opportunity arises and they don't spread their bets too thin. In this context, Immelt has executed in an "outsider" fashion. At GE, he makes "bolt-on" acquisitions that are highly relevant to core businesses (unlike the days of old with NBC) and the timing is compelling: GE invested $11 billion in a six-month energy-related buying spree to take advantage of 2011's depressed prices.
- Pay dividends: Immelt's dividend strategy falls short of Thorndike's ideal, which states that great leaders use dividends as a last resort. GE's 2012 annual report states the following: "[W]e are committed to allocating capital in a balanced and disciplined way, but with a clear priority for dividend growth." GE doesn't stray too far from the pack here, and perhaps that's due to its long history of dividend payouts.
- Buy back shares: Like the acquisition strategy, Thorndike says buybacks should be conducted when opportunities present themselves, not in a cookie-cutter fashion. GE's completed periodic buybacks, but also tends to strike while the iron's hot and the coffer is full.
- Pay down debt: Thorndike emphasizes flexibility regarding debt. CEOs should look for opportunities that bolster the company's return on capital, and I've pointed out that GE's financial position has improved tremendously since the financial crisis. Yes, that period was a near-disaster, but Immelt's come a long way with GE and GE Capital.
- Invest internally in operations: Similar to debt, companies are looking to maximize their returns on capital. Sometimes internal projects offer the most attractive opportunity. Sometimes they don't. GE's investments in everything from natural gas to 3-D printing to the industrial Internet -- all of which are fast-growing concepts -- indicates that the company's placing the right long-term bets.
3. Outsider CEOs are relentlessly focused yet run decentralized operations.
Thorndike points out that the best leaders in his studies had a couple of operational commonalities: They focused on their strengths to dominate those markets and they ran decentralized operations without layers of bureaucracy. With regard to GE, I've outlined my thoughts on the company's strategy to build a lean management approach that resembles a start-up here. In this category, I believe Immelt's pushing GE in the right direction and operating like an "outsider."
To evaluate a true "outsider" CEO I believe there are three key indicators, and that Jeff Immelt's report card would look something like this:
- Stock outperformance relative to peers: C
- Exceptional cash management: B
- Fine-tuned operational strategy: A
As of now, it's hard to argue GE's stock performance has been anything but subpar since Immelt took the helm. That's the criticism most often lobbed in his direction, which ignores the other two categories.
Interestingly, I found one of Immelt's interview comments highly relevant to GE's decade-long predicament. As he is prone to point out, "Never confuse tailwind with good management."
I would say the reverse -- never confuse headwind with bad management -- would also hold true. And in some respects, Immelt's been dealt a tough hand as he pivots GE away from the financial shenanigans of years past. Perhaps, as the winds change course, GE will have some upside down the road.