Podcast Summary
The evolution of shareholder activism influenced by changes in shareholder base: Historically, large holders like the Rockefeller Foundation shaped early shareholder activism. With the diffusion of stock ownership in the 1950s, campaigns became more political and individual-focused. Early capitalists, such as those at General Motors, influenced the ownership structure and thus, the tactics of activism campaigns.
The evolution of shareholder activism has been shaped by changes in the underlying shareholder base. In the early days, large holders like the Rockefeller Foundation held significant stakes in companies. However, with the diffusion of stock ownership in the country during the 1950s, proxy fights became more political campaigns as investors appealed to individual shareholders. This shift was historically rooted in the development of American capitalism, where early capitalists were often strategic investors or bankers. For instance, General Motors had significant ownership from DuPont and made acquisitions using stock, leading to a large number of owner capitalists. Over time, the ownership structure changed, leading to different dynamics in activism campaigns.
Ownership diffusion and reconcentration in public companies: From the 1920s to 1950s, ownership diffused widely, but later reconcentrated into mutual funds, pension plans, and institutional investors. Institutional investors like Ben Graham sought to release shareholder value by acquiring undervalued companies.
During the period between the 1920s and 1950s, there was a significant diffusion of ownership in public companies due to the death of older capitalists and a public interest in owning shares. This led to a brief era of very diffuse ownership. However, starting in the late 1950s and continuing into the 1960s, ownership was reconcentrated into the mutual fund industry, pension plans, and other institutional investors. One notable example of this period is Ben Graham's discovery of Northern Pipeline, a company with vast amounts of undervalued cash. Graham's goal was to release shareholder value by getting this cash into the hands of individual shareholders. The proxy tier movement, which began in the 1950s, marked the start of shareholder populism, with figures like Louis Wolfson and Robert Young advocating for the protection of shareholders' rights. Despite the formation of the SEC and the availability of more public information, accessing this information was still a challenge, making the market less efficient.
NYSE's push for shareholder populism in the 1950s: The NYSE's push for individual ownership and voting rights in the 1950s signaled a shift towards greater shareholder power, but the motivations behind this reform are debatable.
The New York Stock Exchange's campaign for shareholder populism in the 1950s, encouraging individual ownership and voting rights, marked the beginning of a shift towards greater shareholder power. However, it's debatable how much of this was genuine reform versus self-interest. The emergence of conglomerates and hostile M&As in the 1960s and 1970s, as well as the rise of corporate raiders in the 1980s, brought new challenges and responses. Michael Milken's infusion of capital to raiders enabled smaller investors to target larger companies, leading to significant changes in corporate governance. The debate continues on the extent of self-interest versus reform in these historical events.
Activist Investing in the 1980s: Controversial Profit-Makers: Activist investing in the 1980s involved targeting undervalued companies and pushing for changes, but was seen as controversial due to tactics like quick takeovers and ruthless profit-taking. Today, activism is more persuasive, but the small cap market remains ripe for intervention due to poorly managed companies.
During the 1980s, activist investors like Carl Icahn and Boone Pickens made significant profits by targeting undervalued companies and pushing for changes. However, their tactics were controversial, with some seeing them as ruthless profit-takers and others as savvy businesspeople. The era came to an end with the end of the junk bond market and the rise of institutional investors. Since then, activism has evolved into a more persuasive game, with activists trying to convince institutions of their ideas rather than relying on quick takeovers. Despite this shift, the small cap market remains full of poorly managed companies, making it fertile ground for activist intervention.
The Evolution of Shareholder Influence: Institutional investors like Vanguard, BlackRock, and Dimensional, once considered passive, now have robust teams to study governance issues and vote shares, making them active influencers in corporate governance.
The role of shareholders and their influence on companies has evolved significantly over the years. In the nineties, young activists without access to capital often used public embarrassment as their only means to effect change. However, nowadays, institutions like Vanguard, BlackRock, and Dimensional, which were once considered passive investors, have become active participants in corporate governance. These institutions, despite being passive investors in the sense of following indices, have robust teams to study governance issues and vote shares. They are no longer just passive owners but also active influencers. The shift from active selection to passive ownership has led to a new dynamic where passive investors have a significant impact on the management of companies. This raises questions about the future of shareholder value and the influence of large institutional investors. As Lynn Stout, author of "The Shareholder Value Myth," notes, the belief that companies should prioritize shareholder value is a relatively recent concept and may not be as concrete as we assume. The history of shareholder value is fascinating, and it's worth digging deeper to understand its implications for the future of business and finance.
Narrow focus on shareholder value can impact stakeholders negatively: Recognize that maximizing shareholder value doesn't always align with the interests of employees, customers, communities, and the environment. Strive for balance and explore ways to define and measure corporate performance holistically.
The narrow focus on shareholder value in business can lead to short-term thinking, neglect of long-term performance, and disregard for the interests of employees, customers, communities, and the environment. According to Lynn Stout, there is no legal requirement for corporations to prioritize shareholders, but the practical reality is that they must raise capital from somewhere. However, it's important to recognize that the definition of shareholder value can vary, and some argue that long-term interest of shareholders aligns with the well-being of other stakeholders. Ultimately, the challenge is to strike a balance between maximizing shareholder value and considering the needs of all stakeholders. While some companies, like Amazon, prioritize long-term growth, others may be too focused on short-term earnings. Measurables like share price and earnings provide clear benchmarks for shareholder value, but it's more challenging to quantify the impact on stakeholders. Therefore, it's essential to explore ways to define and measure corporate performance in a more holistic manner.
Markets may not accurately reflect company value and executive compensation: Markets can be inefficient, share-based compensation can be erratic, and evaluating companies involves more than just share price.
While share price is a common metric for evaluating company performance, it may not accurately reflect the value of a company or its management. The speaker argues that markets are not always efficient and that share-based compensation, such as stock options, can introduce erratic and unpredictable compensation for executives. The speaker also suggests that the opportunity set for activist investors may depend more on undervalued companies than on governance issues. The speaker shares his personal background, including his experience in a mediocre band and his transition to business school, emphasizing the educational value of his band experience despite its lack of professional success. The speaker's perspective highlights the importance of considering multiple factors beyond share price when evaluating company performance and executive compensation.
Discovering new opportunities through hard work and dedication: Hard work and commitment can lead to unexpected opportunities, like finding success in music or business, or discovering a passion for value investing through a business school class.
Hard work and commitment are crucial for achieving success, even in fields like music or business. The speaker in this conversation recognized that their band wasn't reaching its full potential due to a lack of dedication and unity among its members. They eventually turned to business school as a versatile degree that could lead to various opportunities. At Columbia University, they discovered the world of value investing through a class taught by Joel Greenblatt. Although they had no initial plan to pursue investing, the class resonated with them, and they became deeply focused on the subject. The Greenblatt class was structured around case studies and special situations, which the speaker found particularly engaging. They felt they were understanding the concepts faster than their peers and were inspired by the guest speakers and stock pitching sessions. Ultimately, the speaker's experience demonstrates the importance of being open to new opportunities and seizing them when they arise.
Overcoming challenges and seizing opportunities: Determination and a willingness to step out of comfort zone can help us seize opportunities and grow. Importance of active investing and thorough research, even in a market dominated by passive index funds.
Sometimes opportunities come our way that we may not feel fully prepared for, but with determination and a willingness to step out of our comfort zone, we can seize those opportunities and grow from the experience. The speaker shares how he overcame his stutter to teach at a prestigious investing program, inspired by a friend's success and driven by a desire to challenge himself. Another key topic of discussion was the importance of active investing and the challenge of standing out in a market dominated by passive index funds. The speaker's portfolio, which is far from resembling an index fund, showcases his commitment to value investing and his belief in the importance of thorough research and analysis. The conversation also touched on specific case studies of Stargaz, Popeyes, and Tandy Leather, highlighting the importance of staying true to one's investment philosophy even in the face of market pressure.
Criticism of Eric's decision to have his mother on Star Gas' board: Proper corporate governance and strong leadership are crucial for a company's success, as poor decisions and questionable practices can lead to negative consequences.
Corporate governance and leadership can significantly impact a company's success or failure. The Loeb letters' criticism of Eric 7's decision to have his mother on Star Gas' board highlights the importance of proper corporate governance. The Star Gas debacle serves as a cautionary tale, where the company's poor leadership and questionable decisions led to a public blow-up, investor fatigue, and a tarnished reputation. However, despite the negative attention and macroeconomic pressures, the company's turnaround under new management and good governance ultimately led to a successful outcome.
Companies like Star Gas can generate outsized returns despite declining heating oil business: Star Gas' success comes from good capital allocation, including disciplined acquisitions and buybacks. Historically, large-scale buybacks at discounted prices have outperformed the market.
Despite the secular decline in the heating oil business, companies like Star Gas, which are perceived as terrible commodity businesses, can actually generate outsized returns for investors. This is due in part to the good capital allocation skills of these companies, particularly their disciplined approach to acquisitions and share buybacks. Star Gas, for example, has been successful in acquiring undervalued assets and buying back shares at opportune times. The empirical evidence suggests that companies that engage in large-scale buyback programs, especially when shares are purchased at discounted prices, have historically outperformed the market. However, it's important to note that not all buybacks are created equal, and some may be more manipulative or self-serving than others. It's crucial for investors to carefully evaluate the motivations and execution of buyback programs before making investment decisions.
Misunderstanding of buybacks leading to suboptimal execution: Boards need expertise to evaluate company worth and execute effective buybacks, as they can significantly impact value, either positively or negatively.
Buybacks, a common corporate finance tool, are often misunderstood by boards and management teams, leading to suboptimal execution. Buybacks can significantly impact a company's value, either creating or destroying it. The best performance comes from boards that understand their company's value and execute opportunistic, aggressive buybacks. However, many boards lack the necessary expertise to evaluate their companies' worth and execute buybacks effectively. As a result, buybacks can be a double-edged sword, with the potential to create substantial value or burn money. Activists have increasingly used buybacks as a tool to pressure companies into returning value to shareholders, but their effectiveness depends on the board's understanding of valuation and buyback execution. Research suggests that high-conviction buyback programs, where companies repurchase a significant percentage of their shares at large discounts, tend to outperform the market, offering higher forward returns for investors.
High conviction buybacks lead to significant outperformance: Investing in large, strategically planned buybacks of niche businesses can lead to impressive returns, despite challenges in less liquid, smaller cap stocks
High conviction, larger buybacks that are strategically planned and not just a dividend proxy can lead to significant outperformance in a portfolio, as seen in the case of Tandy Leather. The speaker's firm owns a large stake in Tandy Leather, a niche retail company selling leather and tools to leather crafters, and has seen impressive returns due to the quality of the business and the selling pressure from a large shareholder. The speaker also noted the challenges of investing in less liquid, smaller cap stocks like Tandy Leather, where information disadvantages and liquidity issues can make it difficult to execute a quantitative or systematic strategy. However, the potential rewards of such investments can be substantial, as demonstrated by Tandy Leather's performance. The future of active management may lie in these types of investments, where a long-term view and a deep understanding of the business can lead to outsized returns.
The Role of Active Management in a Data-Driven World: Despite the rise of indexing and quantitative investing, active management remains important for smaller companies and overall. Judgment and access to information are crucial, but separating signal from noise is a challenge. Competition comes from index funds and their tax efficiency, but active managers can navigate market complexities.
While the role of active managers may be challenged in the context of mega cap companies with the rise of indexing and quantitative investing, there will always be a place for active management in smaller companies and across the board. The speaker emphasizes the importance of judgment and access to information, and the potential risks of an imbalance in access to real-time data between large funds and companies. Active investors face the challenge of separating signal from noise in the vast amount of data available. The speaker's firm has been fortunate to have a high-quality investor base of sophisticated individuals, and their competition is the S&P 500 index fund. The tax efficiency of index funds is also a consideration. The speaker acknowledges that it's hard to outperform and expects compression on fees over time, but believes there's a role for active managers in navigating the complexities of the market.
Complex investments and low turnover create administrative burden: Despite strong returns, complex investments and low turnover can deter potential investors due to added administrative hassle. An index fund like the S&P 500 offers comparable performance with less burden.
While the discussed investment firm may excel in delivering strong returns, they acknowledge the administrative burden they impose on their investors due to complex investments and low turnover. The ease of investing in an index like the S&P 500, which offers comparable performance with less administrative hassle, is a significant factor for potential investors. The firm's value-based investment strategy results in infrequent major portfolio changes, which may be due to a lack of compelling investment opportunities. A key moment in the interviewee's career was when Arthur Levitt helped him gain admission to Columbia Business School despite initial reservations, an act of kindness that significantly impacted his professional growth. The interviewee identifies his abilities in big picture thinking and written communication as strengths, but he doesn't believe they set him apart significantly in his peer group. If given the power to force everyone in the world to read one book, the interviewee suggests a thought-provoking title that encourages critical thinking and personal growth.
The Impact of Books in Our Formative Years: Reading influential books during our youth shapes our perspectives and influences how we view the world. Buffett's 'The Snowball' is a must-read for young investors for valuable insights into his journey.
During our formative years, particularly in our late teens and twenties, the books we read can have a profound impact on us. These books shape our perspectives and influence the way we view the world. For instance, reading Ayn Rand in high school had a significant impact on the speaker, even though he later rejected her ideas. However, as we grow older, the impact of books may be less profound, and each book may only result in small changes. Regarding business books, the speaker recommends "The Snowball: Warren Buffett and the Business of Life" as a must-read for young investors. This book provides valuable insights into Buffett's journey and the stages and hardships he faced on his path to success. It's unfortunate that Buffett himself has distanced himself from the book, and it's not as widely recognized as other books about him. The speaker also admires individuals with diverse interests and productivity, such as Tyler Cowen. He wonders how these people manage their time and cover such a broad range of topics. Ultimately, he believes that learning from well-rounded and sophisticated thinkers can yield more insights than from those with narrower interests.
