A few weeks back, Fool co-founder David Gardner discussed the six signs of a Rule Breaking company . Recently, our analysts have been examining each of these signs in greater depth. After the series runs its course, you should be able to identify Rule Breakers for yourself. Today, we'll look at sign No. 4: Good management and smart backing.
"We weren't betting on the Internet. We were betting on Jeff."
-- Jeff Bezos' mother discussing her original investment in Amazon.com.
John Doerr, the fabulously wealthy venture capitalist who guided and helped fund Amazon.com (NASDAQ:AMZN), Intuit (NASDAQ:INTU), and Google, has a particularly odd investing style. He focuses on people. I know, I know, this guy's a bit of an odd duck. He actually feels that it is important to look for individuals who have talent, vision, and leadership when considering investing opportunities. Where did he get such outlandish notions?
Business schools teach ratios, discounted cash flows, and sophisticated modeling techniques. In many of the advanced investing classes, professors spend little time on subjective assessments of company managers. When I asked about the importance of effective management in one such class, there was a hush in the room as if I had just declared my belief in Santa Claus. I was told that effective management would already be reflected in the share price of any particular stock. Silly old me.
This brings us to sign No. 4 of any Rule Breaking company: Good management and smart backing. At Motley Fool Rule Breakers, we spend considerable time performing due diligence on the management of high-growth companies. It's only common sense to think that a Jeff Bezos of Amazon.com or a Reed Hastings of Netflix (NASDAQ:NFLX) will continue to be successful, having already demonstrated vision and leadership abilities throughout their career. But common sense ain't that common in the halls of academe. The key question, it seems to me, is not whether managers are important -- they are. Rather, the key question is: Can you identify the next Jeff Bezos before everyone else does?
What are the clues, Sherlock?
Let's examine Jeff Bezos' career to see if there were any clues that would've allowed us to get in on the ground floor of Amazon.com. Bezos graduated Phi Beta Kappa from Princeton with a degree in computer science and electrical engineering. After college, he went to Wall Street and eventually joined the firm D.E. Shaw, which is known for hiring only the smartest people.
It was at Shaw that Bezos had his road-to-Damascus moment. He was struck by the meteoric growth of the e-commerce industry and, after considerable reflection, he left the Street to set up his own Internet company. He called it Amazon.com, and it would sell -- of all things! -- books.
In 1995, his site opened to the world. By 1996 John Doerr's firm, KleinerPerkins Caulfield & Byers, became the largest institutional investor in the young firm, which went public in 1997. The rest, as they say, is history.
There are several things that stand out in this brief biographical sketch. Bezos was an outstanding student at one of America's top universities. Early in his career, he was employed by one of the most discerning companies on Wall Street. He stumbled upon a compelling idea for a business in a high-growth sector and he had the courage of his convictions to pursue it. And he was able to obtain the most respected e-commerce venture capitalists to back his fledgling company.
Would you have invested in Amazon.com before it became the first profitable e-commerce firm? Fool co-founder David Gardner, the lead analyst for Rule Breakers, did, having invested in the company soon after its 1997 IPO. The $11,000 investment back then as part of the original Rule Breaker portfolio would now be worth $136,107 -- a return of more than 1,100%.
This above all ...
When considering whether a company has good management and smart backing, we like to keep it simple. We look for leaders who are visionary and somewhat daring. Such leaders are usually young, though Jim Sinegal of Costco (NASDAQ:COST) proves that older leaders can also break the rules -- Sinegal is notorious for actually thinking you can treat your workers well and still make a profit. (First, Doerr thinks people are important. Now we have someone believing workers' dignity is important as well. Things are getting curiouser and curiouser, as Alice might say.)
My young Laertes, this above all: Make sure the CEO of your company is honest. This last point is non-negotiable as far as we are concerned. If your company's CEO has a habit of stretching the truth in conference calls, or is constantly massaging his firm's earnings, watch out. At a certain point, those who rely on spin to propel their companies forward will stumble. And then it's a quick trip to the bottom for the stock price.
You're
interviewing them this time
We believe identifying excellent management is crucial to discovering outstanding growth companies. But how do you assess these managers? The small-time investor can't get on the phone and give Steve Jobs a jingle. But the average guy can listen to conference calls. He can read biographies in the financial press. And he can read the transcripts of interviews that are published on free sites like The Motley Fool.
At Rule Breakers, we provide additional support. Our analysts interview several CEOs each month and our growing community relays key information from conference calls. We provide access to interview transcripts with CEOs such as Charles Harris of Harris & Harris (NASDAQ:TINY), a venture capital firm that invests in nanotechnology, and Patrick Byrne of Overstock.com (NASDAQ:OSTK), an online clearinghouse that has eBay in its crosshairs. As a group, we can perform the strict due diligence that is difficult for the individual to carry out.
With so many charlatans and hucksters out there, it's amazing to me how willing many of us are to invest in companies run by people we know nothing about. I know because I'm guilty of this myself. I'm embarrassed to admit that last fall, lured by its high dividend yield, I bought shares in Friedman Billings Ramsey (NYSE:FBR) and only later learned of its management "problems." Did I drop the ball on due diligence? Yup, and I paid dearly for it.
If you agree that all of us should spend more time analyzing the people who run the companies we invest in, try a 30-day free trial to Rule Breakers. Take a look at some of our past recommendations and special features and see if we can assist you in identifying the visionaries of tomorrow. If you don't like the service, you'll get a complete refund. Honest.
For related Foolishness:
- Rick Munarriz reveals sign No. 1 in Be First, Be Great.
- Charly Travers examines sign No. 2 in Thwarting the Big Bad Wolf.
- Tim Beyers checks out sign No. 3 in Invest in Bottle Rockets.
John Reeves owns shares in Netflix and Friedman Billings Ramsey. Costco, Amazon.com, and Netflix are Motley Fool Stock Advisor recommendations. Intuit is a Motley Fool Inside Value recommendation. The Motley Fool has a disclosure policy.
