On What Makes a Good Discerene Management Team
In recent times, we observe that many analysts have become card-carrying members of the “Cult of the Compounder,” a cult that worships at the feet of “outsider” CEOs doing extraordinary things at their companies. It is not obvious to us that one can predict a priori whether such CEOs actually create value for shareholders or whether they simply increase the variance of outcomes at their companies. When CEOs do unconventional things, they will get unconventional outcomes, both left-tail and right-tail. But are their results actually better in aggregate?
As it happens, there is a serious research-methodology problem when analysts decide to study success and thereafter find explanations for them — this is the problem of survivorship bias, reinforced by bedazzling halo effects.1 Many analysts who study success do not test the counterfactual, i.e., case studies of other CEOs pursuing similar “Cult of the Compounder” strategies… and failing. Were analysts to do so, they’d find many examples of spectacular failures. To use but one example, a “public-company LBO” strategy is often a high-stake high-wire act. If the company stays on that wire, the rewards may be grand. If the company doesn’t, the fall may be ugly. CEOs who pull off the high-wire act are feted, but was the opposite outcome equally likely?
It is the study of failure that we find more instructive.
Ergo, the Discerene management Hall of Fame contains many leaders who embrace the “quiet ordinary.” They are not often larger-than-life personalities and instead tend to walk softly while carrying big sticks. They tend to be deeply dedicated to their companies. They tend to focus on their customers and employees. They tend to have strong internal moral compasses and incredible work ethics. They tend to be motivated by intrinsic factors (e.g., a desire to build something that lasts or a culture they can be proud of) and not extrinsic rewards or recognition. They tend to be prudent, frugal, and downside-focused. They tend to be long-term optimistic about their businesses, but not overly so. Instead, they tend to be honest and transparent about the good and the bad of their companies.
Unlike many “Cult of the Compounder” CEOs, they generally don’t seek to transcend the industries they are in by trying to achieve unnatural outcomes for those industries.2 Rather, they are clear-eyed about both the structural advantages their companies possess and the limitations they must work within, and they seek to manage their businesses effectively and for the long term. They seek to be good stewards and safe hands at the wheel. They are nevertheless often visionaries and outliers simply because of their long-term time horizons and willingness to work through near-term challenges with quiet fortitude instead of capitulating to external pressures or demands.
Crucially, they do not “blow with the wind” with the investing and managerial fashions of the day. Here, we are often gobsmacked by how decisions are made by some business leaders. For example, we saw some tech companies announce spending, capital expenditure, and personnel cuts in 2022. In 2021, the very same companies were convincing investors about how NPV-positive their spending and investment decisions were. But why would the NPV of an investment change because of the capital-markets environment? In sharp contrast, Discerene’s Hall of Fame CEOs play offense, and deploy more, not less, capital when their markets are dislocated. They were not just fearful when others were greedy but also greedy when others were fearful.
We prefer to work with CEOs and management teams who are philosophically aligned, just as grittily patient, and focused on making patent the advantages their businesses already possess. We gravitate towards such business leaders because we often invest with large margins of safety (i.e., our downside is often protected in the absence of bad decision making), and we like their businesses (i.e., our upside is substantial if the through-cycle economics of their businesses are realized).
When we find them, it always feels like the dawn’s first light. We do everything we can to help them succeed.
1. See also Rosenzweig (2007), The Halo Effect, Free Press.
2. E.g., trying to achieve >100% ROICs in an industrial manufacturing business or to be #1 in every single business they enter regardless of how unrelated those businesses are.