It is easy to focus solely on outcomes: Managers of sports teams are judged by wins; investors want high returns; and politicians want office.
Some even filter explicitly for desired outcomes, like only hiring managers with strong track records.
As thoughtful people, we would be remiss to not ask why something is working.
Many investors and commentators have suggested that founder-led companies tend to do better than peers. This idea can be more provocatively captured by the question:
“Why two similar companies can deliver substantially different returns over time?”
Here are examples of return comparisons between once similar companies (that operated in the same sector and geography, i.e. the value added from stock selection):
- Amazon.com returned more than 100x the investment from the ashes of the Dot.com bubble at the end of 2002. Over the same period, eBay, another pioneer of online shopping in the early 2000s, returned 4.6x.
- Nordstrom, a family-run US department store operator, returned 4x (over the same 17-year period as above) in what has been challenging times for retailers the world over. Macy’s, another US department store with a recognisable brand, returned 1x.
- Netflix vs. Blockbuster. Netflix started in DVD rentals like Blockbuster. Netflix is now NZ$245bn in market value as the company pivoted into online streaming of videos, whereas Blockbuster is no more.
- And locally, there is Ryman Healthcare vs. Metlifecare, both long standing players in the retirement home sector. Since the end of 2008, Ryman has returned 9.7x compared to Metlifecare 1.1x.
- a2 Milk vs. Fonterra. You know that score.
The difference in returns is staggering and it shows the value of good stock picking. So, how can we get better at this?
Enter ESG (Environmental, Social and Governance) research, the investment industry’s innovation to better understand attributes that can impact long term corporate performance. There is a growing array of attributes within each ESG domain (from use of renewable energy to gender equality, CEO pay, etc.), some will prove to be more pertinent than others. Overall, this pushes in the right direction towards answering the stock selection question of why companies operating in the same sector and geography can deliver such different returns.
Still, sceptics say simply having a high ESG score does not mean a business will grow sales and profits; this is true. But they conflate this issue with another important one – that some sectors are better than others. They confuse the value added through sector selection vs. stock selection. Suffice to say, it is not fair to compare a top ESG scorer in the challenged newspapers sector vs. a poor ESG scorer in the booming online shopping sector. The latter likely comes out ahead despite little attention to ESG because sector fundamentals for online shopping are stronger than traditional media.
In fair comparisons, as per the above examples, the dispersion between the best and the worst within a sector is substantial and the reasons, arguably, intuitive.
Imagine two armies, one made up of fighters defending their homeland and loved ones, the other a group of mercenaries fighting on foreign soil. You don’t need to watch Game of Thrones to know that, all else being equal, the group that has the stronger, personally important, collective mission will come out on top. This is ‘hearts and minds’; it is about people, and it impacts behaviour.
This intangible factor is relevant in businesses because every company has customers and employees, or the need to maintain human relations. A dependable, living wage gets workers to show up (the mercenaries) but to hold down a top performing team, where individuals go ‘the extra mile’, requires something in addition.
From interviewing teams at successful businesses, we think words like ownership, culture, passion, mission, purpose, care, leadership, storytelling, inspiration come closest to describing this intangible factor. Importantly, it is not any single one but the collection of these intangibles, and the ability to demonstrate and communicate this throughout the organisation and have its people opt-in, that matters.
While it does not guarantee success, we aim to be on the right side of these intangibles while investing in favourable sectors.