“Any year that passes in which you don’t destroy one of your best-loved ideas is a wasted year.”
- Charlie Munger (Trades, Portfolio)
I learned some expensive lessons in my early days as an investor.
As an example, I invested in a random solar panel manufacturer because everybody “knew” that solar was the future. How could you possibly lose with that huge tailwind at your back? As you probably could guess, that didn’t work well (in fact, the company eventually went bankrupt).
I eventually learned that growth for an industry does not automatically translate into success for the companies within it. I also learned to appreciate something Warren Buffett (Trades, Portfolio) said many years ago:
“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
In the ensuing years, after taking it on the chin during the financial crisis, I shifted my focus to high-quality companies with a demonstrated track record of value creation for shareholders. This led to positions in tried-and-true blue chips like Johnson & Johnson (JNJ) and PepsiCo (PEP). The ensuing success from those investments (undoubtedly helped by their initiation in the early years of a bull market) reinforced my belief that this was a much better way to invest.
Over time, that led me to believe that the capabilities of the management team of a great business was unimportant. It didn’t matter if Indra Nooyi (the former CEO of PepsiCo) was a great manager or not. She was at the helm of a great business, so who cared?
That led me to glom onto another idea that Peter Lynch first had in 1989 and Buffett later affirmed more succinctly in a 2008 quote:
"Buy into a business that’s doing so well an idiot could run it, because sooner or later, one will.”
That made sense. Managers will come and go. The bad ones will eventually be replaced. That’s a short-term issue that ultimately does not matter to the long-term investor (meaning someone who plans on owning the stock for years or even decades). All that mattered was the quality of the underlying business and the sustainability of the company’s moat (if any).
But in recent years, I’ve come to a more nuanced view. Clearly business quality is very important. But the long-term success of Amazon (AMZN) and the more recent success of Microsoft (MSFT) led me to a different realization: People and culture are very important as well. In addition, organizations with the right culture and people often have the foresight and strategic vision to position themselves to compete – and win – in businesses with attractive economics. Said differently, great managers will do the work that leads them into great businesses.
Amazon’s success in cloud computing with Amazon Web Services (AWS) is a great example. It speaks to the importance of capital allocation and vision; as the years pass, what CEOs do with your company -- and the cash it generates -- has a major impact on intrinsic value.
(From the perspective of an investor with hindsight, consider a few items: (1) AWS was a rounding error a decade ago, and (2) it now accounts for a large percentage, if not the majority, of Amazon’s intrinsic value.)
In March 2016, an engineer wrote about his experience as an employee during the early years at AWS. What he wrote is quite telling. Here are some key takeaways:
"The S3 announcement was game changing. Most startling was the cost of the service. It was nearly 2 orders of magnitude less expensive than we were currently paying for multi-data center redundant storage. But what was even more disruptive was a credit card was all that was needed to provision storage. There was no required proposal for financial approval, there was no RFP, no vendor selection process, no vendor negotiation, and no data center space need be found. I could just sign up and start working.
What was at least as notable as the low cost and ease of provisioning was that the announcement came from Amazon rather than a traditional enterprise IT player. Rather than a company that is dedicated to high margins, difficult negotiations, and sometimes even license usage audits, this service came from Amazon. What looks to be 'large' margins at Amazon would have shareholders at most enterprise IT companies calling for immediate management change. This really was different. A different supplier, a different model, a low friction provisioning path, and a fundamentally different price that starts low and falls rather than escalates over time…
As a member of the AWS engineering team, my first impressions are probably best summarized as fast. Decisions are made quickly. New ideas end up in code and available to customers at a speed that just makes the pace of enterprise IT look like continental drift…
Another interesting aspect of AWS is how product or engineering debates are handled. These arguments come up frequently and are as actively debated at AWS as at any company. These decisions might even be argued with more fervor and conviction at AWS but its data that closes the debates and decisions are made remarkably quickly. At AWS instead of having a 'strategy' and convincing customers that is what they really need, we deliver features we find useful ourselves and we invest quickly in services that customers adopt broadly. Good services become great services fast.
In some of my past roles, I’ve seen these healthy debates become bigger than life and end up dragging on unproductively for years. At AWS they are resolved in days with customer usage data and the focus swings quickly to execution. It’s really refreshing to have the normal debate to delivery equation turned upside down. Most of the effort at AWS ends up in customer hands whereas, at many jobs I’ve held, much of the effort is in bringing these competing internal efforts to resolution. The AWS speed of delivery is great for customers and I find it an exciting environment for engineers."
Amazon’s astounding success in cloud computing wouldn’t have been possible without these key factors: a willingness to commit significant resources to an endeavor outside of Amazon’s core business, a culture that attracted and retained high-quality individuals, and the patience to invest in the business for many years before it made a material impact on Amazon’s financials (at a time when the company had outside investors and Wall Street constantly pushing it to generate profits). Replace Jeff Bezos with your average CEO and there’s a good chance Amazon would’ve completely overlooked a business opportunity that is now worth hundreds of billions of dollars.
That’s difficult to quantify, but it’s incredibly important. As the saying goes, "Not everything that can be counted counts, and not everything that counts can be counted."
When the right managers are given a long runway, it’s amazing what they can do. I’ve seen that firsthand from CEOs like Satya Nadella at Microsoft and Doug McMillion at Walmart (WMT). Time has given me a new-found appreciation for the value of partnering with extraordinary individuals.
Conclusion
My investment strategy is still focused on finding high-quality businesses with sustainable competitive advantages. To paraphrase Buffett, I’m looking for good horses, not broken-down nags. But I don’t think that’s all that matters. What has changed is my appreciation for the jockey – and as importantly, the team and culture around that they build around them. If you find that elusive combination of a high-quality business and best-in-class leadership, that’s when you have truly hit pay dirt. Whatever you do, don’t let those opportunities sift through your hands.
Disclosure: Long Johson & Johnson and Microsoft.
Read more here:
The Value of 'Willful Agnosticism'
Some Thoughts on Electronic Arts
Costco: Maintaining Its Dominance
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