Defer to the CEO

I am a big fan of the Coffee Can Portfolio, an “Active Passive” approach to investing. The idea is simple: You try to buy a basket of the best stocks you can and let them sit for years. You incur no costs with such a portfolio, and it is simple to manage.

You can see my Coffee Can stocks (and their performance) here on my Scorecard.

Unless you are an activist investor, buying a stock is akin to buying a partial share in a business, and retaining management to run that business. This is crucial to recognize. As passive investors, we have no say in how management operates the business, who they hire, who they fire, how they make decisions, how they invest our capital etc. Instead, we must rely solely on their judgement, and their ability to run the company effectively, in a way that hopefully leads to long term stock price appreciation.

CEOs have disproportionate power and influence over a company’s operations and results. Therefore our job as passive investors is to invest in CEOs we can trust.

Said another way...we have to continuously defer to the CEO. They’re really the ones in charge.

So, who can we Trust?

I find that founding CEOs can make great candidates, especially when Investing in Mavericks.

Here are three reasons why:

1. Founders know how to Innovate

2. Founders are Flexible

3. Founders commit to the Long-term

Let’s take a closer look.

Founders know how to Innovate

Recall that Mavericks are companies that approach their industries in completely new ways. Mavericks therefore, are in the innovation business. If they can’t innovate, they will soon disappear into obscurity.

Founding CEOs are great at innovating, and creating something from nothing. I’d argue that Professional CEOs on the other hand tend to be good at scaling, maximizing or optimizing things, not inventing them. Both skills are important though. Therefore, in order for a Maverick to excel, either a Professional CEO must learn to innovate, or a Founding CEO must learn to scale, optimize and maximize. I believe the latter is significantly easier. Great founders can either learn the additional skills required, or they can surround themselves with a team, one that already has these skills.

Since we’re investing in Public companies, it is not a leap of faith to acknowledge that founders who have successfully taken their companies public, have actually learned how to scale, optimize and maximize. If they hadn’t, it is unlikely that they would have gotten this far. Of course this is not always true. Just look at Trevor Milton of Nikola. So we must be careful.

Note: Of course, I am not saying that Professional CEOs can’t innovate. They can: Eric Schmidt of Google and Satya Nadella of Microsoft are both excellent examples. I am just saying that I believe it’s much harder than the other way around.

Founders are Flexible

Since Mavericks approach their markets in completely new ways, Innovation requires First Principles thinking. It often requires throwing out foundational assumptions that an industry may be built upon.

Netflix is probably my favorite example that illustrates the point above. Netflix was the market leader in the movie rentals business, where they distributed physical DVDs. Despite this, Netflix moved away from its old beliefs that customers wanted DVDs mailed to them, and instead invested in streaming.

Doing so was a bet squarely to disrupt itself. Can you imagine the conversations the company must have been having when making that decision?

In hindsight, it was a no-brainer. But I doubt many professional CEOs would be willing to jeopardize their own company’s business model like this. It carries not only financial, but reputational risk.

Here is Reed Hastings’ (cofounder of Netflix) thinking on Flexibility:

Founders commit to the Long-Term

For a Founder, their company is their life’s work.

This means they have more than a financial commitment towards their company, they have an emotional one. As a result, founders tend to care, which often leads them to take a long term view.

Also, the process of starting, building, scaling and taking a company public is long and difficult. 7-10 years on average (I think?). When someone has led a business for that long, they recognize that when they invest in something, it can take years for the returns to manifest. Therefore, by the time a company is public, founding CEOs are accustomed to, and dedicated to the long term. Jeff Bezos of Amazon is probably the best example of this.

Professional CEOs on the other hand are much more likely to be driven by shorter term goals and incentives.

In Summary

CEOs have disproportionate power and influence over a company’s results. Our job as passive investors is to invest in CEOs we can trust. We must therefore continuously defer to the CEO. They're really the ones in charge.

But who can we trust?

I find that founding CEOs can make great candidates. Founders know how to innovate. They can be flexible when necessary. And they tend to commit to the Long-term. All important qualities in predicting success.

Happy Investing!

Next week, I hope to discuss a recent “Defer to the CEO moment”.

You May Also Like:

• The 3 Stages of a Maverick (Part 1): The Disruptors

• The 3 Stages of a Maverick (Part 2): The Contenders

• The 3 Stages of a Maverick (Part 3): The Leaders

• What Maverick Returns Need To Be

• Investing in Mavericks