The Outsiders is a book about eight CEOs whose companies drastically outperformed the market, primarily through a focus on capital allocation. As stated in the Preface to the book all eight CEOs believed, amongst other things that:
- Capital allocation is a CEO’s most important job
- What counts in the long run is the increase in per share value, not overall growth or size.
- Cash flow, not reported earnings, is what determines long-term value
- Decentralised organisations release entrepreneurial energy and keep both costs and ‘rancor’ down
- Independent thinking is essential to long-term success, and interactions with outside advisers (Wall Street etc.) can be distracting and time-consuming
- Sometimes the best investment opportunity is your own stock
- With acquisitions, patience is a virtue … as is occasional boldness.
These insights are profound and, in some cases, fly in the face of what is taught in modern corporate finance courses and is practiced in a typical corporate boardroom.
At 250 odd pages The Outsiders is a short book. It details the lives and business strategies of each CEO in enough depth without getting bogged down in unnecessary details. It covers obscure CEOs, such as John Malone as well as the more famous ones, such as Warren Buffett. Independent of the insights these CEOs can bring investors and business owners, the corporate history contained in this book is also very interesting, such as how Nestle came to own the Purina brand of dog food. That said, I did have a few minor issues with this book.
One problem I have with this book is its exclusive focus on American CEOs and businesses. Now don’t get me wrong, as the largest economy for the last 70 odd years most successful CEOs, due to the American economy’s sheer size, would probably be American. That said, there have been thousands of successful companies outside the U.S which have generated outstanding returns for its shareholders over the long term. Why not discuss at least one of the CEO’s of these businesses? There are 194 countries outside the United States and at least 50 of them are English speaking. Is the approach of these eight CEO’s replicable outside the US? Or did the author only pick CEO’s which fit his hypothesis? Where the results of these CEOs just a result of the ‘American tailwind’ of the last 70 odd years? Do these approaches work in other cultures?
This U.S centric approach shows its Achilles heel in the fact that some of Thorndike’s insights are not always applicable outside the United States. For example, Thorndike’s belief that dividends should almost never be paid because it is tax inefficient ignores the fact that not every business operates in a tax environment where this is the case.
A more accurate argument would be that CEO should allocate capital in the manner which results in the best after-tax returns for shareholders. In the case of Australia and New Zealand, where dividend imputation/franking exists, paying a dividend can be one of the most tax-efficient uses of capital. Other jurisdictions such as Canada have similar schemes which take into account that tax has already been paid on dividends at the company level.
While Thorndike does say a CEO should strive to achieve the outcome which results in the best possible after-tax return for shareholders, his presumption that dividends should never be paid is plainly wrong. He is blinded by his American centric approach.
I admit the author is American and I’m sure it is easier for him to interview American CEO’s than one’s in a foreign country. I also acknowledge that most English language readers are American, so it is understandable to focus on American businesses. This American centric approach does reduce the overall enjoyability of the book, but it is not a deal breaker.
Luck vs Business Strategy
In my humble opinion, Thorndike should have addressed one crucial question: Were all these CEOs just lucky? While I believe these results were primarily due to business strategy rather than luck, not everyone agrees with me. A rebuttal of the luck argument would have added to the book’s argument substantially.
Welch and Competitive Moats
Thorndike is clearly not a fan of Jack Welch, CEO of General Electric from 1981 – 2001. Welch is heralded by some as the paragon of what a successful CEO is. This book is in many ways a rebuttal to this argument. While I agree with Thorndike’s argument, I find it curious that the author continually compares the performance of the eight CEOs in this book against Welch.
This is flawed as GE was operating in a completely different industry to any of the eight CEOs in this book. As Thorndike states, relative outperformance is what really matters. One must compare the performance of CEOs who were dealt the same cards in order to determine whether the exceptional (or unexceptional) results were a result of the CEO or just a result of the industry the company is in.
I don’t think it is a coincidence that so many of these eight CEOs were involved in the cable industry. Why? Because the competitive moats (and consequently financial rewards) of a well-run American cable business were incredible during the lives of these CEOs. The tax advantages and the potential for growth (both organically due to rural American households gaining access and the abundance of acquisition opportunities) meant that very high returns were possible when operated well and excess capital allocated appropriately. GE didn’t stand a chance.
Welch should not have been compared with these CEOs. He was operating in a very different industry. Despite this, Thorndike does provide a much-needed rebuttal to the belief that the Welch Way is the only way to run a company and that he is the greatest CEO ever. Clearly this is not the case, although there is still much we could learn from Welch.
The crucial insight this book gave me was the distinction between allocating capital and operating a business. Every single one of the CEOs in this book had at least one very capable lieutenant who was extremely adept at operating the business. While the focus was the Chief Executive Officer, something must be said for the outstanding ability of each CEO’s Chief Operating Officer. Capital allocation skills of the CEO are great but are of much less use without operational excellence. Both are important.
This is a very well written book. The authors interviews with the CEOs really add to Thorndike’s insights. The Outsiders serves as a useful study in how these eight outstanding CEOs achieved their success. Its no wonder that this book is one of the 11 Picks From Warren Buffett’s Bookshelf. Every investor should read it. 8/10.
The book can be purchased here.