Latest / The Dutch Investors / #104 | Why Most CEOs Are Bad Investors

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#104 | Why Most CEOs Are Bad Investors · The Dutch Investors

• 0:00
  SPEAKER_00: Quick question.
• 0:02
  SPEAKER_00: When you are researching a company, how much time do you spend on the product, the market, the competitors?
• 0:11
  SPEAKER_00: Versus the person actually deciding what to do with the cash the business throws off.
• 0:18
  SPEAKER_00: Think about that for a second.
• 0:21
  SPEAKER_00: For most of us, it's not much.
• 0:25
  SPEAKER_00: We obsess over total addressable market, over increasing margins, but we forget that someone, a single human being, is sitting there every year deciding whether to buy back stock, make an acquisition, pay a dividend, or just do nothing.
• 0:46
  SPEAKER_00: That decision, more than almost anything else, is what determines whether you make money.
• 0:52
  SPEAKER_00: Last week we published our deep dive on perimeter solutions, which is free, and you can check it out over on the Dutchinvestors.com.
• 1:01
  SPEAKER_00: But William Thorndike, the person who wrote The Outsiders, and if you haven't read that book, put it on your list.
• 1:08
  SPEAKER_00: It's one of the best investing books out there, if you ask me.
• 1:12
  SPEAKER_00: But it's not really about investing.
• 1:15
  SPEAKER_00: It's about eight different CEOs who have outperformed the market for a long, long time.
• 1:22
  SPEAKER_00: They've outperformed basically everyone else by doing one thing really, really well.
• 1:29
  SPEAKER_00: So today we're talking about his framework, we're mixing in our own take and giving you a practical way to spot one of these CEOs before the market figures out what they're sitting on.
• 1:42
  SPEAKER_00: We call them the outsiders.
• 1:44
  SPEAKER_00: So let's get into the episode.
• 2:12
  SPEAKER_00: A CEO's real job is not running the company.
• 2:16
  SPEAKER_00: It's not creating a product roadmap.
• 2:19
  SPEAKER_00: It's not marketing campaigns.
• 2:22
  SPEAKER_00: It's not doing keynote interviews.
• 2:24
  SPEAKER_00: A CEO's real job is capital allocation.
• 2:30
  SPEAKER_00: And capital allocation basically means deciding what to do with the company's cash flow to generate the best long-term returns for us, the shareholders, or widening the competitive advantage, which basically in the long run also results in better returns.
• 2:50
  SPEAKER_00: But if you strip it down, a great CEO only needs to do two things.
• 2:55
  SPEAKER_00: Run the operations well, enough to generate cash, and then redeploy that cash to maximize value.
• 3:04
  SPEAKER_00: That's it.
• 3:06
  SPEAKER_00: Everything else is noise for a CEO.
• 3:09
  SPEAKER_00: And there are really only six things a CEO can do with that cash flow.
• 3:14
  SPEAKER_00: Reinvesting into the business, buying other businesses, paying a dividend, paying down debt, buying back stock, or just sit on it and wait.
• 3:28
  SPEAKER_00: And to fund any of that, there are basically three levers internal cash flow, debt, or issuing new equity.
• 3:39
  SPEAKER_00: And every CEO, whether they realize it or not, is running an investment portfolio.
• 3:45
  SPEAKER_00: The problem is almost none of them were ever trained for that.
• 3:50
  SPEAKER_00: They spent 20 years climbing the operational ladder, and then one day they are handed the one job, capital allocation, which nobody taught them.
• 4:02
  SPEAKER_00: So what are the traits that separate a regular or a good CEO from a real outsider CEO?
• 4:10
  SPEAKER_00: What makes them rare?
• 4:13
  SPEAKER_00: A few things, and once you see them, you can't really unsee them, which is the point, to find those outsider CEOs.
• 4:21
  SPEAKER_00: First, they think in per share terms.
• 4:26
  SPEAKER_00: Revenue growth looks great in a press release.
• 4:30
  SPEAKER_00: Market share also looks great in an investor presentation.
• 4:35
  SPEAKER_00: But neither one tells you if you, the shareholder, actually got richer from it.
• 4:41
  SPEAKER_00: Henry Singleton understood this better than almost anyone alive.
• 4:46
  SPEAKER_00: He co-founded Teledyne in 1960 and built it into a sprawling conglomerate of over 130 businesses.
• 5:00
  SPEAKER_00: Mostly by acquiring companies with Teledyne's own richly priced stock.
• 5:06
  SPEAKER_00: And then, once the buying spree was done, he flipped the switch completely.
• 5:12
  SPEAKER_00: And between 1972 and 1984, he shrank Teledyne's share count by around 90%, buying back stock through tender offers when it was trading at single-digit earnings multiples.
• 5:26
  SPEAKER_00: He didn't care about revenue at all.
• 5:29
  SPEAKER_00: He cared about one metric, value per share.
• 5:34
  SPEAKER_00: Which brings us to the second trade.
• 5:37
  SPEAKER_00: Outsider CEOs run brutally lean, decentralized organizations most of the time.
• 5:44
  SPEAKER_00: This is not always the case, but it helps.
• 5:48
  SPEAKER_00: But it is a trait we saw over and over again in the Outsider Book.
• 5:53
  SPEAKER_00: Tom Murphy took over a single small TV station in Albany back in 1966.
• 6:00
  SPEAKER_00: And by 1985, Capital City's communication was big enough to acquire ABC for$3.5 billion.
• 6:09
  SPEAKER_00: A deal roughly three times the size of Capital City's itself.
• 6:14
  SPEAKER_00: And through all of that, Murphy ran the whole thing with an HQ staff you could count on two hands.
• 6:22
  SPEAKER_00: Capital Decision stayed with Murphy, on purpose, because that split kept him focused on the one job that actually compounds value for a CEO.
• 6:32
  SPEAKER_00: The third trade, they're patient to the point of looking almost passive, and then suddenly being aggressive when the price is right.
• 6:43
  SPEAKER_00: Singleton would go years without buying back a single share.
• 6:48
  SPEAKER_00: Then he'd tender for enormous blocks all at once when the stock got very cheap.
• 6:54
  SPEAKER_00: John Malone did something similar at TCI.
• 6:58
  SPEAKER_00: He took over in 1973 when it was a small, heavily indebted cable operator and spent the next 25 years turning it into the largest cable company in America, largely by using debt and depreciation to keep reported earnings and therefore taxes low, while cash flow kept compounding underneath.
• 7:21
  SPEAKER_00: He set out entire cycles before buying cable systems at prices competitors simply couldn't justify.
• 7:30
  SPEAKER_00: This one's underrated by the way.
• 7:33
  SPEAKER_00: Doing nothing for long stretches doesn't generate headlines, and it makes the board nervous.
• 7:40
  SPEAKER_00: Most CEOs simply aren't allowed and can't sit still, but an outsider CEO can.
• 7:48
  SPEAKER_00: Which brings me to the fourth trait.
• 7:51
  SPEAKER_00: Outsider CEOs think like sellers as much as buyers.
• 7:57
  SPEAKER_00: Catherine Graham took control of the Washington Post in 1963, right after her husband's suicide with zero business background and steered it through the Pentagon's papers.
• 8:10
  SPEAKER_00: Watergate, a brutal pressman strike.
• 8:13
  SPEAKER_00: She and her eventual successor, Alan Spoon, sold off the company's weaker assets and funneled the proceeds into buybacks and higher return businesses.
• 8:25
  SPEAKER_00: Every unit had to earn its place, and nothing was untouchable just because it had always been there.
• 8:33
  SPEAKER_00: Let's talk about the fifth trade.
• 8:35
  SPEAKER_00: They avoid the trappings of the job entirely.
• 8:40
  SPEAKER_00: There's no headquarter building with their name on it, there's no fancy private jet.
• 8:47
  SPEAKER_00: They don't focus on or do barely any interviews.
• 8:51
  SPEAKER_00: And it's not really personality.
• 8:54
  SPEAKER_00: It's the same obsession that drives good capital allocation, actually.
• 8:58
  SPEAKER_00: It's about not wasting shareholder money.
• 9:02
  SPEAKER_00: Whether that's on an overpriced acquisition or having a fancy lobby or office.
• 9:09
  SPEAKER_00: And the sixth trait is these outsider CEOs think in decades.
• 9:14
  SPEAKER_00: They don't think in quarters, or sometimes not even in years.
• 9:18
  SPEAKER_00: Warren Buffett has said for literally decades that Berkshire will never smooth its results to keep analysts happy.
• 9:27
  SPEAKER_00: That only works if your board and your biggest shareholders are willing to judge you over years, decades, not over a 90-day window.
• 9:37
  SPEAKER_00: Which is exactly why long-term insider ownership matters so much on that list.
• 9:43
  SPEAKER_00: A bad CEO is easy to spot.
• 9:46
  SPEAKER_00: Think about debt field growth, revenue targets that ratchet up every year, no matter what the price was paid to hit them, a buyback program running on autopilot regardless of valuation.
• 9:59
  SPEAKER_00: This is not so hard.
• 10:01
  SPEAKER_00: The hard part is telling a good CEO from a truly great one.
• 10:07
  SPEAKER_00: A good CEO runs the operations well, hits the targets, delivers good returns, and basically hands capital allocation off to a CEO.
• 10:18
  SPEAKER_00: And sometimes hands off capital allocation to a CFO, who can do the job just fine.
• 10:25
  SPEAKER_00: An outsider CEO does the analysis personally.
• 10:29
  SPEAKER_00: They're willing to make a call that looks bad in the short term, an idle balance sheet, a cancelled dividend, selling off part of the business because they believe it's right for shareholders over the next decade.
• 10:42
  SPEAKER_00: And honestly, the tell is what they're willing to take criticism for.
• 10:47
  SPEAKER_00: A good operator wants to look busy and decisive.
• 10:50
  SPEAKER_00: An outsider is fine, looking boring, even wrong for a couple of years, because the decision was rational when they made it.
• 11:00
  SPEAKER_00: They're optimizing for per share value a decade out, so not sentiment this quarter.
• 11:06
  SPEAKER_00: So how do we actually try to spot the outsider CEO?
• 11:10
  SPEAKER_00: Because Thorndike had the luxury of hindsight.
• 11:14
  SPEAKER_00: He picked eight CEOs whose results were already in the history books.
• 11:19
  SPEAKER_00: We don't get that as investors.
• 11:21
  SPEAKER_00: We have to spot the behavior before the stock price tells us we were right, which sometimes means being wrong, or at least looking wrong for a while first.
• 11:32
  SPEAKER_00: So here's what we do step by step.
• 11:35
  SPEAKER_00: We start with the shareholder letter.
• 11:38
  SPEAKER_00: Does the CEO walk you through specific capital allocation decisions and the reasoning behind them?
• 11:45
  SPEAKER_00: Or is it just a page of vague language about culture, strategy, and vision?
• 11:51
  SPEAKER_00: Singleton, Buffett, Malone, they all wrote letters that read like memos.
• 11:58
  SPEAKER_00: They told you what went wrong.
• 12:00
  SPEAKER_00: It's nice to read, they're honest, they're transparent.
• 12:04
  SPEAKER_00: They told you what they were working on, they explained things clearly instead of hiding behind jargon.
• 12:12
  SPEAKER_00: We also check where the CEO came from.
• 12:15
  SPEAKER_00: Half of Thorndike's eight CEOs were first-time CEOs, and most were new to their industries entirely.
• 12:24
  SPEAKER_00: Think about it, someone who spent 30 years climbing inside a company usually inherits the company's assumptions along the way.
• 12:33
  SPEAKER_00: An outsider to the industry has to think from first principles, which happens to be the exact habit you want in a capital allocator.
• 12:43
  SPEAKER_00: We also look at skin in the game.
• 12:46
  SPEAKER_00: Not just does the CEO own stock, most of them do, or they're granted, but did they buy it with their own money?
• 12:55
  SPEAKER_00: Or is it all grants?
• 12:57
  SPEAKER_00: And how does that stay compared to their salary?
• 13:00
  SPEAKER_00: A CEO whose net worth is mostly in the company itself thinks about a buyback very differently than one whose net worth is mostly in cash compensation.
• 13:12
  SPEAKER_00: We also check the buyback history against the current share price.
• 13:16
  SPEAKER_00: Not whether a buyback program exists, whether it actually responds to the valuation is what matters.
• 13:23
  SPEAKER_00: A company that repurchases stock mechanically every single quarter, regardless of valuation, isn't practicing capital allocation.
• 13:32
  SPEAKER_00: They're running a script.
• 13:34
  SPEAKER_00: We want the company that goes quiet when the stock is expensive and gets aggressive when it's cheap.
• 13:41
  SPEAKER_00: We also look at how the company talks about divestitures.
• 13:44
  SPEAKER_00: Outsiders sell the underperforming, non-core stuff without getting sentimental about it.
• 13:50
  SPEAKER_00: If a division has been dragging for a decade and management keeps it around because it's part of our culture or history, it's the opposite signal we're looking for.
• 14:01
  SPEAKER_00: We also look for the CEO saying publicly that their own stock is too expensive to buy back, and that single sentence runs against almost every incentive a CEO has, which is exactly why it's worth listening to.
• 14:17
  SPEAKER_00: And we check succession.
• 14:20
  SPEAKER_00: Outsiders tend to groom their own replacement rather than rather than hiring an external.
• 14:27
  SPEAKER_00: Look at Murphy worked side by side with Dan Burke for two decades before handing him the keys.
• 14:34
  SPEAKER_00: Graham handed hers to her own CFO.
• 14:38
  SPEAKER_00: Buffett spent years grooming Greg Abel, an internal successor trained in the same discipline is a much stronger signal than an outside hire brought in to, I don't know, modernize the culture or whatever.
• 14:53
  SPEAKER_00: So none of these on their own prove anything.
• 14:57
  SPEAKER_00: You can probably apply some of them to any CEO.
• 15:01
  SPEAKER_00: But together, they start painting a picture of whether a CEO is optimizing for per share value or just wants the appearance of running a tight ship.
• 15:12
  SPEAKER_00: But we have to be honest here.
• 15:14
  SPEAKER_00: This framework can also burn you, and we'd be doing you a disservice if we stopped there.
• 15:20
  SPEAKER_00: Because this framework can bite you.
• 15:23
  SPEAKER_00: Thorndike's book has a survivorship problem, plain and simple.
• 15:29
  SPEAKER_00: Like I said before, he picked eight CEOs because the returns were already exceptional, and then reverse-engineered the trades.
• 15:38
  SPEAKER_00: There were also almost certainly other CEOs who were just as decentralized, just as frugal, just as patient, and whose companies still underperformed because the underlying business or timing was wrong.
• 15:53
  SPEAKER_00: Capital allocation skills matter, but it's not the only variable.
• 15:57
  SPEAKER_00: Some of these exact traits can destroy value too.
• 16:01
  SPEAKER_00: Eddie Lampert split Sears Holdings into more than 30 separate business units back in 2008, each with its own PL, its own board, its own management.
• 16:13
  SPEAKER_00: The logic was Murphy's internal competition drives performance.
• 16:18
  SPEAKER_00: Instead, the units hoarded resources and cannibalized shared brands like Kenmore, and 10 years later, Sears was bankrupt.
• 16:28
  SPEAKER_00: Extreme patience can look identical to indecision, right up until it doesn't.
• 16:34
  SPEAKER_00: Barens ran a cover in 1999, literally asking, What's wrong, Warren?
• 16:40
  SPEAKER_00: After Buffett refused to touch internet stocks and Berkshire trailed the SP 500 by double digits that year.
• 16:48
  SPEAKER_00: The dot-com crash hit three months later and proved Buffett was completely right.
• 16:53
  SPEAKER_00: But there was no way to know that from inside 1999.
• 16:57
  SPEAKER_00: None.
• 16:58
  SPEAKER_00: Being contrarian or concentrated is exactly what makes an outsider.
• 17:03
  SPEAKER_00: Ride up until the bet doesn't work.
• 17:06
  SPEAKER_00: 3G Capital ran Kraft Heinz on the same zero-based budgeting playbook that made their earlier deals look brilliant.
• 17:15
  SPEAKER_00: But then came a$15.4 billion write down on Kraft and Oscar Mayer brands in 2019, once the cost cutting had hollowed the brands out from the inside.
• 17:27
  SPEAKER_00: Buffett, whose Berkshire held a big stake, later admitted flat out that he'd overpaid and made a mistake.
• 17:34
  SPEAKER_00: There's also a pricing trap.
• 17:36
  SPEAKER_00: Once management earns a reputation as disciplined capital allocators, the market bakes in a premium into the company.
• 17:44
  SPEAKER_00: Jack Welsh GE traded at a premium for years as the best-run conglomerate in America, and that premium would unwound hard after he left.
• 17:55
  SPEAKER_00: Once the leverage buried inside GE Capital came to light under his successor.
• 18:02
  SPEAKER_00: Buying a stock because the CEO reminds you of Henry Singleton is not the same thing as checking whether today's decisions still make sense at today's price.
• 18:12
  SPEAKER_00: And maybe the hardest one.
• 18:44
  SPEAKER_00: Sometimes they're just quiet.
• 18:47
  SPEAKER_00: So, here's where we net out.
• 18:51
  SPEAKER_00: Capital allocation is genuinely undertaught and is genuinely decisive for long-term returns.
• 18:58
  SPEAKER_00: Decentralization, patience, a relentless focus on per share value, a willingness to sell as easily as they buy.
• 19:08
  SPEAKER_00: These trades show up again and again in businesses that have compounded value far ahead of their peers.
• 19:15
  SPEAKER_00: But the honest truth is there is no real framework that reliably tells you who the next outsider is going to be.
• 19:24
  SPEAKER_00: This one doesn't either, and we're not going to pretend otherwise.
• 19:28
  SPEAKER_00: What it does give you is a sharper set of tools, a sharper set of questions to ask before you hand a management team a premium multiple just because they talk a good game about capital discipline.
• 19:42
  SPEAKER_00: At the end of the day, this stuff is deeply subjective.
• 19:46
  SPEAKER_00: A framework helps you ask better questions, but a lot of it still comes down to gut instinct, timing, and a healthy dose of luck.
• 19:56
  SPEAKER_00: That's it for today.
• 19:58
  SPEAKER_00: And as always, stay curious, keep learning, and happy investing.