Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 292

The 'founder' mindset of an astute investor

Investing is about understanding businesses and as with all things business-related, nothing is ever clear-cut. Businesses are comprised of a set of strategies which have been selected and implemented by management. However, no one can guarantee the success of a business strategy - not even management themselves. So what hope does an investor have?

In this article I’ll explore the characteristics of a certain type of investor who holds an advantage. I’ve termed them the ‘entrepreneurial investor’.

Business owners think differently

In 1947, Benjamin Graham coined the term the ‘enterprising investor’. He outlined how an edge could be gained by delving deep into the numbers to determine the true underlying value of a business. But that edge is harder to find these days. There are simply less cigar butts and more people looking for a free puff. It’s a tough game if you’re relying only on that strategy.

So, if studying the numbers won’t give you an edge, what will? One of the answers I believe, lies in the saying ‘walking a mile in one's shoes’. If you’ve ever run a business or grown a business, big or small, you have an edge over those that haven’t. You are an entrepreneurial investor. You possess an understanding of business that can’t be appreciated through research alone. As important as the numbers are, they are only the first step of analysis. What’s more important is being able to judge which numbers are important and knowing when to use intuition.

So, put yourself in the shoes of a founder - someone focused solely on growing the business over the long term. What truly matters to you and how you operate your business will be drastically different to a fly-in CEO chasing a bonus.

If you haven’t owned a business or run a business, all is not lost. You just need to understand a few principles of how good business owners think, then apply them in your judgement as an investor.

Seeing opportunities when conservative investors don’t

Running and growing a business involves the optimisation of multiple levers, such as decisions about the best allocation of fixed resources for maximum long-term return. If you have been in that position, you will know what constitutes good capital allocation.

I’ll illustrate this by way of a real-life example of a company we are currently tracking.

Consider a dominant furniture retailer going through a transition period. After many years of leading the market, lower consumer sentiment has led to a recent decrease in sales. In addition, customers are increasingly heading online for homewares. Investment analysts have punished the stock for its recent earnings decreases. In response to the evolving market, the founding family and majority shareholder recently appointed a new CEO with a mandate to spend significant resources on a new digital online store. This expenditure has led to an even greater short-term cost blow out.

Conservative investors would steer clear of this investment. On the surface it seems like a dinosaur industry set for extinction. Investors would look instead for the ‘safe’ cash cow blue chip that pays a high yield.

However, for entrepreneurial investors, this represents a clever investment opportunity. Sentiment is low and the stock has not been this cheap for many years. The significant investment in the online store is a shrewd move by the founders. The direction towards digital distribution has been managed prudently and early results are promising. The once-off investment cost has masked the imminent turnaround and transition opportunity.

Entrepreneurial investors understand that allocation to growth projects is not optional, it is a necessity. Risk is part and parcel of improvement. Improvement is not a choice; if you’re not improving, you’re a sitting duck. What’s most important is that the allocation of capital to this project is thoughtfully considered and prudently managed. Look for favourable risk/reward trade-offs even though conservative investors may see differently.

Betting on moats, not news

Anyone who’s started their own business venture knows that new initiatives take time. Usually longer than anticipated. Jeff Bezos of Amazon, one of the world’s most successful founders, outlines his thinking on results,

“Today I’m working on a quarter that is going to happen [three years from now]. Not next quarter. Next quarter for all practical purposes is done already and it has probably been done for a couple of years.”

For most fundies, Bezos’s three-year time frame is too long. A fundie could change careers multiple times in that period. Fundies need to pick up quick results and so they favour a quarter-to-quarter game of news arbitrage. It relies on betting on news announcements, rather than betting on business moats. For investors to truly bet on a business moat, they need to allow ample time for the growth initiative to crystallize.

One such business I visited recently in Japan transformed itself from a printing company into a data provider. They now dominate the Japanese food industry - a slow moat-building process which has taken them 10 years to establish. Initially starting by digitising print data for their customers, they developed software that now owns the pricing data of the Japanese food advertising market. It is difficult for competitors to cross the moat.

Some strong Australian examples

Business owners understand the power of human nature. People, when aligned and motivated, can achieve great things. Drive, heart and nous are the most important things in a business but are instead often overlooked in favour of well-credentialed management teams with little vested interest.

When Warren Buffett took over Berkshire Hathaway, it was a struggling textiles business. Although you wouldn’t have backed the original textile business itself, you would have backed Buffett’s ability to change the core business.

Australian visionaries Roger and Andrew Brown (ARB Corporation), David Teoh (TPG Telecom), Andrew Hansen (Hansen Technologies), Frank Lowy (Westfield), Barry Lambert (Count Financial), and Graeme Wood (Wotif.com) have been the heart and soul behind their companies. These founders have demonstrated an incredible ability to compound shareholder wealth, i.e. their own wealth. Those who have invested alongside them have been repaid handsomely. They’ve all demonstrated a shrewd ability to take calculated risks and look for hidden opportunities.

Entrepreneurial investors understand that backing the right people is just has important as backing the right business. To do this sensibly, investors need to ensure there is genuine motivation and desire to further the growth of the business for the long term.

For this reason, we favour investing in founder-led companies

Investors with experience owning and running their own business have an edge over the typical conservative investors. They are 'entrepreneurial investors'. They’ve been in the shoes of management. They know what’s important and they’re comfortable backing the right people with carefully considered strategies. They recognise that business success requires continual improvement and calculated risk-taking. By drawing on this experience and combining it with financial analysis, they have more strings to their bow than the typical conservative investor.

Happy compounding.

 

Lawrence Lam is the Founder of Lumenary, a fund that uncovers the best founder-led companies in the world. We invest in unique, overlooked companies in markets and industries beyond most managers’ reach. The material in this article is for general information only and does not consider any individual’s investment objectives.

 

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Superannuation

The 'Contrast Principle' used by super fund test failures

Rather than compare results against APRA's benchmark, large super funds which failed the YFYS performance test are using another measure such as a CPI+ target, with more favourable results to show their members.

Property

RBA switched rate priority on house prices versus jobs

RBA Governor, Philip Lowe, says that surging house prices are not as important as full employment, but a previous Governor, Glenn Stevens, had other priorities, putting the "elevated level of house prices" first.

Investment strategies

Disruptive innovation and the Tesla valuation debate

Two prominent fund managers with strongly opposing views and techniques. Cathie Wood thinks Tesla is going to US$3,000, Rob Arnott says it's already a bubble at US$750. They debate valuing growth and disruption.

Shares

4 key materials for batteries and 9 companies that will benefit

Four key materials are required for battery production as we head towards 30X the number of electric cars. It opens exciting opportunities for Australian companies as the country aims to become a regional hub.

Shares

Why valuation multiples fail in an exponential world

Estimating the value of a company based on a multiple of earnings is a common investment analysis technique, but it is often useless. Multiples do a poor job of valuing the best growth businesses, like Microsoft.

Shares

Five value chains driving the ‘transition winners’

The ability to adapt to change makes a company more likely to sustain today’s profitability. There are five value chains plus a focus on cashflow and asset growth that the 'transition winners' are adopting.

Superannuation

Halving super drawdowns helps wealthy retirees most

At the start of COVID, the Government allowed early access to super, but in a strange twist, others were permitted to leave money in tax-advantaged super for another year. It helped the wealthy and should not be repeated.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.