Rudi's View | Oct 01 2020
This story features CSL LIMITED, and other companies. For more info SHARE ANALYSIS: CSL
By Rudi Filapek-Vandyck, Editor FNArena
I recently finished reading Good To Great. Why some companies make the leap … and others don’t by US author/researcher Jim Collins.
Admittedly, I haven’t been exactly quick in catching up on the author’s global best-seller research.
This book was originally published in 2001 and has sold more than three million copies since.
As it was, I needed a tip-off from new FNArena team member Mark and a little respite post the August reporting season. Plus the fact that Good To Great is available in bricks and mortar book stores around my neighbourhood.
Collins’ five-year study in what makes a small group of US companies a better breed than the majority of peers is aimed at helping entrepreneurs and business leaders to see the light. The author has since built a successful advisory & consultancy career.
But there is plenty of knowledge embedded in those 300 pages for everyday investors watching and researching opportunities among listed companies worldwide.
Truth to be told, I think many an investor would do him/herself one gigantic favour in buying this book and absorbing its content, including the finer details.
Collins’ research started in 1996, involved 21 research associates and ultimately took five years, during which 1435 Fortune 500 companies over several decades were analysed, studied, sliced and dissected, interviewed and ultimately mostly rejected. (Note: The Fortune 500 is not static in make-up but is regularly updated).
As such, the study neatly fits in with Arizona State University’s Hendrik Bessembinder’s findings that, when taking a long-term view, most listed companies turn out to be lousy performers and poor creators of lasting shareholder wealth.
Two years ago, Bessembinder found that over the long term, share market gains can be explained through as little as 4% of the best performing stocks in a study that went back in time as far as 1926.
The latter study certainly raised a few eyebrows, to put it mildly, and I have seen a number of asset managers publishing comparable data-analyses since.
Their numbers might look a little different, but their conclusions are not: when it comes to investing in listed equities, investors better be extremely cautious, as very few companies that are successful today are able to remain successful over the next three, five, seven, ten years, or longer.
Instinctively, this has been my view over the past decade or so. While I never have done the finer data-crunching, there is plenty of evidence around for whoever has an excellent memory to rely upon, or who dares to look back in time through data-details.
BHP Group shares peaked near $50, twice, in late 2007 and in 2011. They have never managed to surpass the $42 level over the period since, spanning thirteen years during which the share price sank as low as $13.
Three of the four major banks are today trading well-off share price levels pre-GFC, and similar observations can be made for the likes of Newcrest Mining (peaked in 2011), Rio Tinto (2008), Scentre Group (2016), Suncorp Group (2007), Telstra (1999), and Woodside Petroleum (2008).
These are all ASX Top20 members in 2020; household names that feature in many investment portfolios and are broadly considered as “must have” backbone portfolio constituents by many, both retail and professional investors.
Probably the most deceptive document that is happily passed on inside the global finance sector is the long-term price graph from Vanguard showing equity indices tend to move upwards as time goes on.
Look under the bonnet, and that’s not what most individual share prices do. AMP shares were once priced above $20 ($1.35 today). Perpetual shares have halved over the past five years.
These are not idly-piddly, teeny-weenie, micro-cap exploration companies with no revenues and nothing to sell.
Which is why, on my assessment, most investors would do well from taking notes from research published by the likes of Jim Collins and Hendrik Bessembinder, and incorporate their key findings in strategies and portfolio composition.
For example: I am regularly informed by investors “I did relatively well” or “I achieved a satisfactory return” from, say, a stock like QBE Insurance.
Below I have included the price chart for QBE Insurance shares over the past ten years (source: ASX).
Has there been another way of achieving a “good” return from these shares other than buying on persistent weakness and then quickly selling on the upswing, with the key requirement not to stay on board for too long?
(I mean, other than deluding myself into thinking I am doing well when the market in general mirrored the QBE share price in the exact opposite direction.)
It’s not as if the dividend has been growing steadily along the way down either.
Here’s one thing I learned from many years of observing the Australian share market: “valuation”, be it “under”- or “over”-, is nothing but of short-term importance. Quality, however, is what shines beyond the immediate.
This has always been the case, but even more so during times of low growth, shorter cycles, low inflation and the emergence of new technologies that challenge most mediocre and sub-par performing businesses.
This is why buying “cheaply” and laggard “value” stocks has performed so poorly as an investment strategy over the past seven years.
Sure, they all have their moment under the sun, and sometimes the gap between “winners” and “laggards” is stretched too far, and it needs to narrow, as happened on occasion and surely it will happen again.
But once you manage to identify the truly great companies, you need to worry a lot less about what happens in the short term. Time to roll out that favourite quote from Warren Buffett himself:
“What’s your favourite holding time? Forever!”
What needs to be added is: but only for the truly great companies.
What makes a great company?
It’s a shame Collins’ Good To Great research is nearly twenty years old. But I am also confident that if it had been updated this year, it would have identified a number of today’s “winners” as meeting the requirements to be labeled a truly great company: Microsoft, Amazon, and Merck come to mind, among others.
The true value of Collins’ research, in my view, is by spelling out the characteristics of the many not so great companies out there: hubris at the top, ill-timed and overly optimistic acquisitions, lack of structural investment, copy-cat strategy decisions, company boards filled with career yes-men, low quality products and services, holding on to yesterday’s glory,..
These are all observations investors can make themselves. No need for an Excel spreadsheet or detailed analysis of the balance sheet. Ever dealt with a Telstra support line? Talk to an IT specialist about the systems that run the banks (you will be shocked).
The inconvenient truth, one that the investment industry is all too willing to swipe under the carpet, is that mediocre companies can only achieve sustainable, great returns for investors when they are carried by extraordinary tailwinds for their industry, or through a monopoly, by law or otherwise.
The past two decades have seen Australian companies losing most cosy market dominating positions, with negative consequences for shareholders. Adaptation and successful transformation are not widely used buzzwords by corporate Australia.
My personal point of interest is when Australian companies venture offshore. A truly great company manages to replicate its success elsewhere. Think CSL ((CSL)), of course, but also Amcor ((AMC)), Macquarie Group ((MQG)), Xero ((XRO)), Aristocrat Leisure ((ALL)), Computershare ((CPU)), even Ansell ((ANN)).
These are all truly international operators, genuine leaders in their field.
Now compare their price charts post GFC with those of Telstra, National Australia Bank, InvoCare, ANZ Bank, Cash Converters ((CCV)), et cetera.
It doesn’t feature in any of the analysis or research I have seen elsewhere, including Good To Great, but when Australian companies fail overseas it does ring an alarm bell for me, and mostly it is but a matter of time before the share price starts trending south.
Equally valid: if Good To Great was to be updated today, the research methodology would have to be amended to take into account the many changes impacting on the world, including this year’s pandemic (and related changes).
As is readily acknowledged throughout the study, great companies are not 100% safe from bad luck, negative impacts or unforeseen disasters, but they cope a lot better, and tend to always come out on top stronger.
Good things happen to great companies. Mediocre peers need luck, lots of it, as well as lots of help and assistance.
Which takes me to my own research into All-Weather Performers on the Australian stock exchange.
During and post GFC, I didn’t know about Good To Great, and neither did I anticipate how skewed share market returns turn out to be in the long run, as laid bare by Bessembinder, but I instinctively felt investors’ core narrative and approach are flawed.
Not all companies are the same. Not all stocks should be treated in the same manner.
For too long, investors have been singularly focused on buying cheaply priced assets, while ignoring the blatant fact that certain companies are simply made from superior substance.
Admittedly, these are a small, selective group, but they do exist, and most portfolios would benefit greatly from at least having some exposure.
This is not to say that anything is destined to last forever. (Sorry, Warren). Things can and do change over time and companies that once were on their way to greatness, or achieved greatness, have subsequently lost that status, with dire consequences for loyal shareholders. Think GE, or Boeing.
In a similar fashion, the lists of stocks I have selected over the past decade have seen some changes, mostly from companies disappearing because circumstances change, or because my initial assessment wasn’t as robust.
Overall, however, the most common questions I receive is when do I intend to update my lists, or whether I should include this or that stock.
It is but a genuine signal that when it comes to selecting great companies on the stock exchange, stability in quality and performance, as reflected in lists inclusion, remains one of the stand-out characteristics.
Certainly, temporary share price weakness does detract nothing from a great company’s core quality, or from the underlying long-term trend for its share price.
Observing corporate greatness is understanding why it should be included in every long-term oriented portfolio and strategy. So, start observing, and act accordingly.
Paying subscribers at FNArena have 24/7 access to a dedicated segment on All-Weather Performers, including eBooks and eBooklets written and published since 2012.
Good To Great. Why some companies make the leap … and others don’t by Jim Collins, Random House Business Books, 300 pages, ISBN 9780712676090.
(This story was written on Monday 28th September, 2020. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: firstname.lastname@example.org or via the direct messaging system on the website).
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