If you've been an investor for any length of time, you know that many events can cause a stock to drop: Bad earnings, analyst downgrades, interest rate rumors, short sellers -- the list goes on and on. But here's an event you may not have pegged as a cause for your stock's recent slide: Your CEO just bought a palatial new estate.
According to recent research by Professors Crocker Liu and David Yermack, "Future company performance deteriorates when CEOs acquire extremely large or costly mansions and estates." Why? Because it signals entrenchment -- fat cats ready to rest on their laurels.
Not that there's anything wrong with that
While richly rewarded CEOs have come under fire of late, far be it from me to begrudge someone the opportunity to live large. Rather, the reason I find the Liu/Yermack study so interesting is that identifying engaged leadership is one of the best ways for individual investors to buy into best-performing stocks of the next decade or more.
Many of the top-performing stocks of the past three years, including Health Grades
That said, I fully expect the leaders of each of these companies to someday move on, and when that happens, the entrepreneurial spirit that has spurred these mammoth gains will be gone as well.
What happens when zealots move on
For evidence of the consequences here, consider the cases of Home Depot
But look at what's happened since Marcus and Blank retired in 2000, and Gates stepped down as CEO. The stocks have stagnated.
Moreover, Gates announced that in July 2008 he will step down entirely from a full-time role at Microsoft to focus on his work at the Bill & Melinda Gates Foundation. This is wonderful news for Gates, his wife, the foundation, and the people the foundation will help -- but can Microsoft keep up its momentum?
Contrast that situation with that of another stock that's started rising recently: Berkshire Hathaway
The Foolish bottom line
Individual investors have few better friends in the marketplace than engaged and entrepreneurial CEOs. Of course, home purchases or new endeavors aren't the only indicators that a CEO is no longer fully focused. That's why you need to keep tabs on the leadership of your companies as closely as you do the financials.
At our Motley Fool Hidden Gems small-cap investing service, we believe that the leadership effect is even more amplified when it comes to small companies. And when you combine great leadership with a wide market opportunity, you have the opportunity for huge returns.
These are precisely the situations we seek at Hidden Gems, and our strategy has helped us beat the market by 22 percentage points since 2003. If you'd like to see the stocks we're recommending today, click here to join Hidden Gems free for 30 days. There is no obligation to subscribe.
This article was first published on April 17, 2007. It has been updated.
Tim Hanson owns shares of Berkshire Hathaway. The Motley Fool owns shares of Berkshire. Microsoft, Home Depot, and Berkshire Hathaway are Motley Fool Inside Value recommendations. Garmin, Berkshire, and Morningstar are Stock Advisor picks. Garmin is also a Global Gains choice. The Fool's disclosure policy is the one who wants to be with you. Deep inside, it hopes you feel it, too.