Crazy Ideas: In Business and Investing, Conventional Wisdom Doesn’t Generate Superior Results
Acting a little crazier may help deliver better results.
A recipe for mediocrity is doing what everyone else is doing. Achieving superior results requires acting or thinking differently. Not surprisingly, occasionally bucking conventional wisdom is a common trait of top investors and CEOs.
Non-Consensus & Right
Investing is a game of expectations. What matters is how results compare to expectations. The average forecast, or consensus expectation, is what’s reflected in the price of a stock at any given time. Surprises are what move stocks. For example, if Netflix is expected to add five million new subscribers in a quarter and they add only four million, the stock likely drops. However, if three million new subscribers are expected and Netflix adds four million, the stock likely rips higher.
Achieving above average results requires a forecast that is non-consensus and right. As distressed securities investor and prolific memo writer Howard Marks notes, this isn’t easy:
Everyone’s forecasts are, on average, consensus forecasts. If your prediction is consensus too, it won’t produce above-average performance even if it’s right. Superior performance comes from accurate non-consensus forecasts. But because most forecasters aren’t terrible, the actual results fall near the consensus most of the time — and non-consensus forecasts are usually wrong.
Here’s what the payoffs look like:
Acting on a non-consensus idea is hard, but it’s very lucrative when you get it right.
Outsider CEOs
The ability to sometimes go against the grain is a hallmark of successful CEOs as well according to William Thorndike’s book The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. Thorndike surveyed CEOs that generated persistent industry-leading shareholder returns like John Malone at TCI, Katharine Graham at the Washington Post, and Warren Buffett at Berkshire Hathaway and found a set of common traits. These included focusing on per share metrics (versus absolute revenue or income), prioritizing cash flow over reported earnings, frugality, and running decentralized operations while centralizing capital allocation decisions.
Capital allocation is one of the most important roles of a CEO. This refers to how a company invests in operations, makes acquisitions, pays down debt, and returns capital to shareholders through buybacks and dividends. Capital allocation is investing, and similar to Marks, Thorndike found that the CEOs most effective at capital allocation followed a non-consensus playbook. For example by eschewing dividends, aggressively buying back stock when valuations were low, and making large acquisitions when prices were attractive. Patience and acting opportunistically were common threads. This was a group that looked to buy low and sell high. When a good price was offered they’d divest a business line and they wouldn’t blink to shutter a unit that was no longer generating adequate returns.
According to Thorndike:
At the core of their shared worldview was the belief that the primary goal for any CEO was to optimize long-term value per share, not organizational growth. This may seem like an obvious objective; however, in American business, there is a deeply ingrained urge to get bigger.
The consensus view in American business fetishizes growth and empire building. Thorndike’s CEOs thought differently and executed well. In other words, they were non-consensus and right.
Outsiders was published in 2012. Amazon CEO Jeff Bezos could be a good candidate for inclusion if Thorndike were writing Outsiders today. Bezos has a maniacal focus on long-term free cash flow generation (though Thorndike would prefer if this were free cash flow per share). He disdains dealing with Wall Street analysts, doesn’t speak on earnings calls, and seldom meets with investors or attends investor conferences. Frugality, one of the common characteristics of outsider CEOs, is one of Amazon’s leadership principles. Lastly, Bezos has the ability to divest when returns aren’t there, like recognizing the failure of the Fire Phone, writing the program off, and moving on.
Somewhat hopefully, Thorndike attributes a large part of the outsiders success to temperament as opposed to superior analytical or intellectual ability:
In the 1986 Berkshire Hathaway annual report, Warren Buffett looked back on his first twenty-five years as a CEO and concluded that the most important and surprising lesson from his career to date was the discovery of a mysterious force, the corporate equivalent of teenage peer pressure, that impelled CEOs to imitate the actions of their peers. He dubbed this powerful force the institutional imperative and noted that it was nearly ubiquitous, warning that effective CEOs needed to find some way to tune it out.
If you want to produce superior results, you can’t do what everyone else is doing.
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