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:
http://michaelmcgaughy.blogspot.hk/2013/04/research-alpha-and-research-beta.html).
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.
Investing in the local markets of Asia can seem like a daunting task for investors based in North America or Europe. Asian markets have proved quite treacherous at times, including due to economic volatility, corporate governance, accounting, and other concerns. While some Western investors have given up on investing in Asia or have relegated their Asian investments to ADRs or ADSs, others have continued to prosper in Asian local markets.
