Disciplined Growth Strategies Of Unsuccessful Companies Pt – 2

Steve Pomeranz: So far in 2017, the stock market has gone up handily, and it’s shown to be a real growth market. But companies that are actually considered high-growth have surpassed the S&P 500 in performance this year by something going on 40%. So, something is going on here, and I want to get to the bottom of it.

So I’ve invited Peter Cohan, and Peter’s been analyzing stocks since 1988. He’s a Forbes contributor and he just published his 12th book, which is entitled, Disciplined Growth Strategies: Insights from the Growth Trajectories of Successful and Unsuccessful Companies. So even if you’re not an investor but you’re running a business, you’re going to want to listen to this as well.

Now, I make it a practice not to mention individual companies on my show, but I’m going to make an exception today because we’re going to use them to learn some important points. These are not recommendations; we’re not touting anything here; we’re just talking. Peter Cohan, welcome to the show.

Peter Cohan: Thank you very much.

Steve Pomeranz: So, Peter, companies come in all shapes and sizes. Some of them are old line, Steady-Eddie dividend payers. Some are cyclical companies, like energy companies, and some are companies that focus on high growth. So, what kind of a company is it that gives us the sustainable growth that the market will reward over time?

Peter Cohan: Well, I wrote a book about this topic because I think it’s very, very important. And I came to conclusion that companies that are able to sustain growth over a long period of time have some common characteristics. And while I certainly don’t want to recommend any individual stocks, I think it’s useful to focus on these three characteristics if you are looking for companies that are likely to be able to sustain growth over a long period of time.

Steve Pomeranz: Yeah, so they’re more about management characteristics and as well as kind of some financial characteristics, but we’ll get to that in second. What is the financial picture for most US big companies today? I mean, in terms of cash, how much cash do they have on the balance seat in order to grow their companies?

Peter Cohan: Well, cash has been piling up to record levels of nearly $1.7 trillion. And I’m not sure how much of that cash is in the US and how much overseas waiting to be repatriated. But companies have accumulated huge amounts of cash since the financial crisis back in 2008.

And what’s kind of interesting now, or fairly recently, is that Goldman Sacks did some research that was published a few weeks ago where they found that between the period leading up to 2015, companies that were buying back their stock and issuing dividends tended to perform well. But starting in January 2016, the companies that were focusing the most money on capital expenditures and R&D outperform the S&P 500 by 4.6 percentage points. So, there has been a recent change where companies that are starting to invest all that cash are doing better.

Steve Pomeranz: Some of this has to do with fad and fashion; sometimes growth stocks are in fashion, sometimes value stocks. Companies that pay good dividends, buy back their own shares, are in fashion.

But there is something definitely going on here. I mean, in January of 2016, the market suffered a pretty significant correction down 10 or 12%. And then in February, March, it really started to inch up until it is where it is today…and this show is as of November 2017.

And as you said, the growth part of the market has outperformed. Yet most companies that I look at are still talking about buying back stock and increasing their dividend. Are they missing the point?

Peter Cohan: Well, how should I say this politely? In my humble opinion, there’s no need to pay a CEO millions of dollars or tens of millions or hundreds of millions of dollars to buy back stock or increase dividends.

I don’t think that requires a lot of skill. I mean, I think a computer could do that. But in order to be a growth company, I think it requires tremendous skill and talent and creativity and willingness to take risk and all those intangible management characteristics that I was referring to before.

So, I have a tremendous amount of respect for CEOs that can do that and for investors. One of the things that I think is an interesting thing to look at is companies that were founded by an entrepreneur and are still run by that entrepreneur and have now reached $8 billion in revenue or above and are still growing at 20% a year.

So, to use those financial characteristics of companies, companies like that that are still run by their founders, I think, are really the most exciting companies. Just from the standpoint of their ability to reinvent themselves and sustain their growth. And clearly, what happens to a company when it gets to that scale is it becomes more and more difficult to find growth that enables them to sustain 20% growth, and it’s just extraordinary.

Steve Pomeranz: Well, it is very easy to just go ahead and buy back stock. That shrinks the amount of stock on the statement, and, therefore, a dollar’s worth of earnings actually increases because it’s spread out among a less amount of shares. So, that’s an easy one.

Increasing the dividend is kind of easy and doesn’t entail a lot of risk. But actually spending a billion dollars on buying a new business or building a new business, that takes the risk of failure. And I would think that a lot of these CEOs, not the ones that you mentioned, but a lot of the CEOs out there are kind of trying to protect their jobs and protect their paycheck.

Peter Cohan: Yeah.

Steve Pomeranz: Would you say I’m characterizing that correct?

Peter Cohan: Yes, one of the things that I find quite striking is that some of these companies have their bonuses tied to earnings per share increases. When they buy back stock, what they’re doing is they’re using shareholder money to pay themselves a dividend of because they increase the EPS by reducing the number of shares outstanding, and then it makes it easier for them to meet their target, which, I just find, there’s a governance issue there.

Steve Pomeranz: I agree, I agree. And plus, they’re buying back their stock; their stock could be selling at a very, very high price, and so it could be a bad future investment.

Let’s talk about these characteristics. So you mentioned companies, large companies, that are still run by their founders. And one company that you mentioned in your article is Amazon.

Peter Cohan: Yes.

Steve Pomeranz: So, they have somehow created the ability to grow very, very fast, to grow very, very large, and still maintain that rate of growth. I mean, that seems to be almost impossible.

Peter Cohan: Well, it is almost impossible because Jeff Bezos is such an extraordinary human being. I don’t know if I would call it investing, but identifying companies that are super successful is a matter of finding a very small number of very talented people, and Jeff Bezos has that talent.

I mean, I can describe what it is about Jeff Bezos that makes him so successful and makes Amazon continue to grow. But it doesn’t mean somebody else can start doing that because of the words I say. I mean, essentially, one of the most important ideas behind Amazon is the idea that every day is day one.

And that’s a term that he uses, and he’s written about in almost every letter he’s written to the shareholders. Is this idea that the company is thinking about itself as if it was just getting started, rather than a $136 billion revenue process that’s growing at 22% a year.

And as a result of that, he’s always kind of trying to get better and always very much fighting complacency. And also, of course, making big investments such as—I can’t remember how much they invested to buy Whole Foods, something like $13 billion. So and what’s also interesting is in their latest quarter, they reported 32% revenue growth as opposed to their 22% long-term average.

So, they’re actually beating their longer-term average growth rate.

Steve Pomeranz: Well, one of your points that you describe, in terms of the personality or the talent that you mentioned, is this idea of finding someone who’s running the company or group of individuals that practice intellectual humility. Would you say that Bezos reflects that?

Peter Cohan: Yes, and it’s kind of ironic because he seems extremely confident. I’m sure he is very confident. In fact, in my view, somebody who’s very confident is quite happy to engage other people in an intellectual debate and have people who disagree with him. And there’s something very powerful about a CEO who doesn’t just issue orders but actually hires really, really smart people and wants them to debate.

Steve Pomeranz: That’s number two on your list, ability to attract and motivate top talent.

Peter Cohan: Yes, I mean the two are definitely related. If you have intellectual humility, you can attract great people because they see the results that you’ve created. And they realize that if they work with you, they’re gonna benefit because they’re going to have such an exciting work environment.

But they’re also going to have a chance to think. They’re not just going to be hired to kind of take orders. They’re going to be hired to think and act and to come up with new ideas themselves. And I think that people who are very talented find that to be an extremely exciting environment.

Plus, they like to work with other so-called A-players, the really best people. So this is very, very important because he can’t do it all himself.

Steve Pomeranz: And I will tell you that thinking is really hard [LAUGH]. I think doing is easier, creating checklists, doing your thing, filling it out.

But sitting there and thinking and coming up with creative ideas and understanding the marketplace and seeing how things correlate with each other and interact kind of in a matrix style thing, that is a very, very difficult thing. And not a lot of people can do that. My guest is Peter Cohan.

His 12th book is Disciplined Growth Strategies: Insights From the Growth Trajectories of Successful and Unsuccessful Companies. We’re going to come right back with Peter because we’re going to discuss a company that seems to be headed on an unsuccessful path, and I’m talking about General Electric. Stay with me, be right back.