Monday, April 15, 2013

Cut Out the Middle. People = Equity

I am still searching for ways to best explain the philosophy behind my ‘group’ research and why it is important.  My research starts with looking at the background and history of the controlling shareholders, as well as all the companies he/she/it controls.  I do as much research on the listed and unlisted companies and spend as much time on the non-core businesses as the core businesses.

There are likely many different ways to explain what I do depending on the listener’s background. 

My last post was written for financial professionals.  In that article I introduced two expressions – “research beta” and “research alpha”.  I contrasted the type of research used to generate consensus earnings forecasts – ”research beta” – with the more background, people and structure focused research that I emphasize – “research alpha’ (See: 

After posting this, I thought of another, non-investment-jargon way of explaining the philosophy behind what I do. Here goes….

Firstly, it has been written many times before that business is about people.  The equation can be written: "people = business". 

Secondly, equity represents an investment in a business.   By definition equity represents a legal claim on a business.  It represents the difference between assets and liabilities of that business.  The equation can be written: "business = equity". 

Cut ‘business’ out of the middle and we are left with a direct link between people and equity.   Or rewritten: "people = equity".  Equity is about investing in people.

From this simple equation it becomes clear that equity investors should evaluate the people behind the business’ they own.  However this is rarely done for listed companies.  When was the last time you’ve seen a research report with an objective or even critical assessment of the key family, people or entity that controls a listed company?

Visiting and meeting management is different than objectively evaluating their background and history.  It is a good information point, but a meeting or two does not replace looking at someone’s past actions and background.  Bernie Ebbers (Worldcom) and Eka Tjipta Widjaja (Asia Pulp and Paper) likely charmed the socks off many corporate and investment bankers while building their companies.  At the end of the day they were behind two of the largest corporate defaults before the 2008 meltdown.  

I would also argue that people are more important in emerging markets where the legal system, regulatory agencies, and business infrastructure is not as entrenched as in more developed countries.  

In my experience more emphasis and attention is placed on people in South East Asia, the Indian-subcontinent, and greater China than in the West. In most developed Western countries the emphasis is comparatively more focused on institutions and rules.

Another reason as to why people are more relatively more important in Asian and emerging markets is that many of the largest listed companies are relatively young; they are typically majority owned by their founders and their descendants, and are tightly controlled by the founding family.   Think of Li-Ka Shing and his Cheung Kong group, the Lim family’s Genting group, or Guo Guangcheng’s Fosun International group. 

Luckily there is a lot of publicly available information about most ‘tycoons’.  In many Asian countries wealthy tycoons get as much press coverage as rock and movie stars do in the US and Europe.

There is also a wealth of publicly available data as reporting requirements have increased in most Asian and other markets in the last three decades.  Insider buy-and-sell data can be important trading signals.  Related party transactions provide a window into the tycoons’ non-listed businesses.

Even in the West individuals are important.  Think about Steve Jobs and Apple.  His history as an innovator, businessman and marketing guru were well known when he returned to Apple in 1996.  Betting on him and his background turned out to be of the better investments of all time with Apple's share price increasing from its 1996 range of US$4.50 - US$8.50, to over US$700 in 2012.

People also impart their culture and values on the companies they lead. This can be especially true of the founders.  This initial corporate culture can take a life of its own with older employees reinforcing existing culture and corporate history to newer ones; or only hiring new employees that fit-in. One of my favorite examples is Astra International, which was started by the very honorable Soeradjaya family.  It remains one of the best-managed companies in Indonesia despite the founders having sold their stake over 15 years ago.

Research also bears this out.  I forget the exact reports I read, and I may be rusty on the numbers, however I remember several stating that share prices decline by something like 50% on average within five years of the founder’s death.  (Apple shareholders take note?)

People are important in every occupation, but especially in business.  Decisions have to be made and people are behind each and every one of these decisions.  Understanding the business from the controlling owners' perspective is something that is overlooked by many analysts and should be emphasized more.

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