The Investment Checklist

by Michael Shearn

  Is the Manager Interested In Money or Motivated By Money?

  How do you determine if a manager is interested in money rather than motivated by money? You simply look at their spending habits and how they live. Passionate leaders make little time for other activities or hobbies, and have few outward signs of wealth. They are narrowly focused on the business at hand. In contrast, some managers seek social approval by having big homes and nice belongings. The difference between the two is that one manager is interested in money and the other type is generally motivated by money. People who are interested in money tend to be conservative in their spending habits, whereas managers who are motivated by money tend to have liberal spending habits.

  For example, Warren Buffett’s personal spending habits have remained the same, while his net worth has increased enormously through the years. Similarly, Dave and Sherry Gold, founders of dollar store retailer 99 Cent Only Stores, have lived in the same home since 1963 and Dave drives an older Toyota Prius. When I asked Sherry Gold why, she answered, “We had everything we wanted that was achievable through money.”6 Money serves as a score, and it does not significantly change their personal lifestyles.

  While spending and lifestyle can be an indicator of motivation, it isn’t always definitive. Some high-performing CEOs live in big mansions, such as Leslie Wexner, founder of retailer the Limited (owner of Victoria’s Secret). He may have liberal spending habits, but his motivation for running the business is more than just making money. Study the managers in-depth to understand the source of their motivation.

  To begin studying a CEO’s lifestyle, start by compiling a set of articles that focus on the CEO, using a news-archiving service such as Dow Jones Factiva. For example, there were many articles written about Stephen Hilbert, CEO of insurance firm Conseco, and his larger-than-life lifestyle. Articles about Hilbert reported lavish parties in his 23,000-square-foot mansion in Carmel, Indiana. His home included a full-size replica of Indiana University’s Assembly Hall, and he and his friends wore Hoosier uniforms when they played basketball. Most investors ignored his personal lifestyle because the stock price rose 46 percent a year, compounded, from 1988 to 1998. However, these aspects of Hilbert’s personal lifestyle should have been warning signals because they indicated he was motivated by money rather than just interested in money.7

  What happened to the company? On December 17, 2002, Conseco filed for bankruptcy, and the high returns investors had previously earned were wiped out completely.

  If you cannot find articles written about the lifestyle of a manager, you can look up the value of their homes, which will give you a glimpse into how they live. Ownership of certain assets such as residential real estate is generally fairly transparent. You can check for residential real estate at the county level where the manager lives. For example, in Austin, Texas, you can search www.traviscad.org, which is the website for the local taxing jurisdiction. You can usually search for properties by the name of the person. First, find out which city the manager lives in and then determine the name of the county and the taxing jurisdiction. In most cases, the county will list the ownership of properties online and you can see the tax value of the home as well as its size.

  For example, suppose you’re interested in learning more about Warren Buffett’s lifestyle. A simple online search will tell you that the tax assessor for Omaha is in Douglas County. You then go to the Douglas County tax assessor website, and enter “Warren E. Buffett.” On the site, it lists that Warren Buffett owns a 1921 home sitting on three quarters of an acre of land, with 5,830 square feet with five bedrooms, and a handball court, valued at $660,200 in 2010.

  If you want to try a more comprehensive real estate search, there are public records companies that have combined many of the local public records into national databases, allowing you to search for holdings across different counties and states. This would yield information on second homes, vacation homes, and so on. Keep in mind that these properties may be held in the CEO’s name or in the name of a spouse or business entity.

  Does the Manager Focus on Appearances Instead of the Business?

  Managers who are truly passionate about their business have less time for outside social engagements. Steve Jobs, founder of Apple, did not spend his money lavishly when he was one of the richest people in the world, and he claimed to have little time for a social life. He was on a mission to make computers as common as kitchen appliances, which at the time, was dismissed as hype.

  It is important to look for distractions managers have outside of the business. The biography found in the proxy statement is a great starting point because it lists the other activities of the top five executives, such as sitting on the boards of other public companies and non-profit affiliations. You want to gain a basic understanding as to whether they are devoting a large amount of their time to other activities. Do they sit on socially prestigious boards in their community? If so, how much involvement does the organization require? Try to gain insight into what motivated the manager to join the board: Was it for social prestige, or was it because he or she is truly interested in the mission of the non-profit? And keep in mind that just because a manager is dedicated to great causes, such as the community, diversity, or other socially responsible goals, this does not necessarily translate into good ethics. For example:

  Ken Lay, who was then the Chairman of Enron, donated $1.1 million in 1999 to endow the Kenneth L. Lay Chair in Economics at the University of Missouri-Columbia. Lay was later convicted of conspiracy and fraud after Enron failed.

  Alfred Taubman gave significant gifts to the University of Michigan in Ann Arbor, and buildings named for him include the Taubman Medical Library and Taubman Health Care Center. There is even a school within the university named for him, the Taubman College of Architecture & Urban Planning. Yet he spent a year in jail after being convicted in 2001 for price fixing at auction house Sotheby’s.

  Dennis Kozlowski, the former CEO of conglomerate Tyco International, donated millions to Seton Hall University, and its Stillman School of Business was housed in an academic building named for Kozlowski. Yet he was convicted of looting Tyco of $600 million.8

  Many times, you can infer the motivation of managers by the number of large social or charity events they attend. For example, when I searched for information about the CEO at a large Texas oil business, all the articles written about him related to his attendance at high-profile social events. I could not understand how he made time for the actual business! I later interviewed him and asked him why he had so much available time to attend all of these social functions, and he answered that he had capable people running the organization. Although this seems like a rational answer, his absence hurt the business, the stock price fell, and he was eventually fired by his board of directors.

  What Type of Philanthropic Endeavors Is the Manager Involved In?

  Philanthropy can be a great window into the character of a manager. There is a considerable amount of public disclosure in philanthropy. You want to determine what managers care about. Are they seeking social acceptance in their community? Or are they genuinely passionate about the charities they give to? In the case of philanthropy, it is a warning signal if the manager is overly involved in social scene philanthropy—that is, the kind that’s more about the social recognition than the charity itself. This indicates that the manager is externally motivated and tends to seek acceptance of those who are in high social standing. Many times, these managers will direct corporate assets to support their social climbing. When you see a business contributing money to the most elite social functions, then it is likely that the manager is using the corporation to improve his or her social standing in the community. These types of donations typically do not pertain to the company but are instead used for social leverage.

  To counter a common assumption that philanthropists always have the greater good at heart, consider a few examples:

  All of Enron’s key officers were active philanthropists, with a gr
eat number of nonprofit organizations in the Houston area benefiting from their contributions.

  WorldCom and Bernie Ebbers were well known as donors to charities and universities in Mississippi, and were respected in the community.

  Adelphia, once one of the biggest cable television companies in the United States, used to sponsor Christmas pageants and flew cancer patients to health facilities for treatment.

  Yet all of these businesses are now defunct and many of their executive officers have served jail time.

  What can you really tell by studying a manager’s charitable giving or philanthropic patterns? Where can you find how and how much a business or person donates? Look for articles about gifts in some of the news stories you read about your company or management. Most corporate and personal giving is direct and isn’t reported in any uniform way, though some giving may be through a foundation. If the manager or company has created a foundation, you should be able to scan the foundation’s tax return because it is a public record. You can request it from the IRS or just check an online provider, such as GuideStar. Look for Form 990, which will detail which groups received gifts, the location and the amount of the gifts, future gift commitments the foundation has made, and contributor names and amounts. Companies will publicize some of this on their websites, but not all of it. Look at more than a year or two, and you can see what the general pattern and focus of their giving is.

  Some other ways to turn up additional information include checking websites and regional newspapers by adding the CEO’s spouse to your search. You can also check publications and websites of non-profits where you know the CEO serves on the board or giving lists or honor rolls of their alma mater or universities with which they are affiliated. There are also companies that collect and cumulate donation records that have been made public at one time or another. All these can offer a glimpse into the social priorities of the manager you are evaluating.

  Are the Managers Lifelong Learners Who Focus on Continuous Improvement?

  Lifelong learners are managers who are never satisfied and continually find ways to improve the way they run a business. This drive comes from their passion for the business. It is extremely important for management to constantly improve, especially if a business has been successful for a long period of time. Look for managers who regard success as a base from which they continue to grow, rather than as a final accomplishment.

  For example, Michael Bloomberg, eponymous founder of the financial information and media company, wrote, “We’ve got to improve just to stay even. Each of us at Bloomberg has to enhance his or her skills. Every element of all our products must be improved. . . Most companies never upgrade until they are forced.”9

  The opposite of those who improve are those who are complacent. Complacent managers tend to think everything is okay and often lack passion for the business. They are satisfied, sometimes indifferent, and usually fall into mediocrity as a result. They often remain invested in the way they have done business in the past, such as when Eastman Kodak refused to acknowledge the threat to its film business from digital photography in the 1990s.

  Another example is mobile phone manufacturer Nokia, which was one of the most successful European companies: In fact, in 1998, it was the world’s biggest mobile phone manufacturer. Nokia was able to get to the top of the industry quickly, but once there, it became complacent. Nokia CEO Olli-Pekka Kallasvuo tended to focus on hanging onto market share instead of creating new products. He ignored the trend of mobile phones merging with computing when Apple introduced the iPhone in January 2007, and he continued to focus on making cellphones that were about calling people instead of about checking e-mail, getting directions, or checking the weather. After the introduction of the iPhone, Nokia’s stock price fell 49 percent, and Kallasvuo was eventually replaced as CEO.10

  49. Can you identify a moment of integrity for the manager?

  Basically, if CEOs have integrity, they are honest. They don’t say something to a group of people just because that’s what the group wants to hear. When you ask a question, they tell you what they really think. In contrast, if a CEO often says, “We’ll go in this direction,” but acts differently, be cautious. If the CEO sets certain standards of behavior or expectations of performance, yet violates them personally, then you should perceive that the manager lacks integrity.

  How can you learn if the CEO has integrity? One indicator is consistency between what they say and what they do. For example, Warren Buffett, CEO of Berkshire Hathaway, says the same things over and over again, and he follows through in his actions. In contrast, politicians are typically not consistent in what they say or do, which is why so many people are suspicious of them. They often say one thing in order to get elected and then do another.

  Another way to observe consistency in behavior is to see how people act under different circumstances. You never truly know someone’s character until you have seen it tested by stress, adversity, or a crisis, because a crisis produces extremes in behavior. A billionaire Chinese entrepreneur once told me that he would not do business with a person unless he had seen them encounter a moment of integrity, which he explained as “how you act when you are confronted with a crisis or an ethical situation.” He then said that if it took him 20 years to wait for a person to encounter this moment of integrity, he was more than willing to wait in order to do business with them. He had a hard-and-fast rule that has served him well, and he was rarely disappointed by his business partners.

  One of the best ways to determine whether a manager has integrity is to identify a moment where he or she faced a difficult situation and see what action he or she took. If you are unable to identify a moment of demonstrated integrity, then you are taking the risk that you do not know how that person will act when faced with a difficult situation. You may want to wait to increase the amount you invest until after you have seen management encounter such a moment.

  There are many examples (many already covered in this book) of CEOs who have presented false results through accounting fraud. These CEOs are often concerned with losing access to new capital, defaulting on loan covenants, or they may be worried about how Wall Street views them. Such CEOs typically fail to consider the broader implications of their actions. You want to know if the manager you are evaluating will follow the right path when faced with adverse scenarios.

  For example, I once attended an annual meeting of a bank in Texas. The morning before the meeting began, the bank put out a news release announcing it had finalized a deal with a Texas billionaire, whereby he would give them a large capital infusion that diluted existing stockholders. Our firm believed this deal was detrimental to existing stockholders, but I wanted to verify this with company management at the meeting. The annual meeting lasted half an hour, and when it came time for the CEO to take questions from the audience, I raised my hand. Within moments, the CEO stepped down from the podium and declared that the meeting had ended. Surprised, I walked over to the CEO and again tried to ask him a question, but he said that he had to attend the board meeting. I recognized most of the board members, who were still socializing in the room. In that moment, the CEO had failed to demonstrate integrity. In other circumstances, I had had a more favorable assessment of this CEO because he was typically straightforward with information, but in this small act, he demonstrated a lack of integrity. This particular bank eventually went bankrupt due to aggressive lending.

  In contrast, when I was researching the background of Dave Gold, co-founder of retailer 99 Cent Only Stores, I was searching for articles that would give me insight into his character. I ran across an article that described how Gold had admitted to making a mistake in purchasing a business for 99 Cent Only Stores. Instead of writing off this investment (as most other CEOs would have), Gold acquired it back from the company with his personal funds—in the amount of $34 million, no less!—which was twice what his company had paid for it previously. I had never heard of a CEO buying back a mistake in order to benefit sharehold
ers, especially at two times the price. I felt I had a deep insight into Gold and knew this was the type of CEO I wanted to partner with, and I made an investment in the business when the stock price fell.11

  The most difficult time to assess a manager is during normal times. You gain more insight into management when conditions are adverse than you do when circumstances are ideal. As you read historical articles written about the business or SEC filings, begin to identify those periods when the business encountered a difficult situation, such as an economic downturn, product recall, negative media coverage that was inaccurate or overblown, or a lawsuit. Read articles, press releases, and transcripts of quarterly conference calls that were written during this time, and note how the management team responded to these difficult situations. If you are assessing a manager with limited tenure at the business, review articles and conference call transcripts at the prior business. Did the manager disclose more information to shareholders, or did the manager clam up?

  For example, during the recession that began in 2007, some managers disclosed more information so their shareholders could better understand the operations of the business and what the management team was doing to cope with the difficult economic situation, whereas others did not want to disclose information, citing a lack of visibility as the reason. This was a weak excuse, however, because managers do not need to forecast the future, but they do need to disclose how they are reacting to a difficult situation. You need to determine how a manager responds to a difficult situation and then evaluate the action they took. Were they calm and intentional in dealing with a negative situation, or were they reactive instead? Ideally, you should seek to partner with those managers who solve problems for the long term.