Two of the smartest portfolio managers I know—Scott Schoelzel, of the Janus Twenty Fund (the best-performing large-cap fund of 1998), and Fred Kobrick, who Moneymagazine called “one of the top five portfolio managers of the decade”—believe so strongly in the importance of management that they insist on meeting with the top managers of a company before investing a dime.
If you have the time and the ability to meet management in person, by all means, do it. But mostly you won’t have this luxury.
You’ll have to rely on shareholder’s meetings, television appear- ances, newspaper or magazine articles, and the like.
This chapter describes what to look for in a management team.
It explains four factors I like to see in a company and why. Keep in mind, these are the things that I ideally like to see. Just because a company violates a rule doesn’t mean it’s destined for failure.
WHATMIKELIKES
● The founder of the company still works there and is under 50 years old.
● The founder off-loads the running of the company to someone else.
● The management team keeps a cool head in times of crisis and isn’t afraid to bring in an outsider to fix things.
● The company takes hiring extremely seriously. Manage- ment gets the best people and does whatever is necessary to keep them sharp and satisfied.
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L E A R N F R O M M Y M I S T A K E S
It’s easy to write about success. I’ve been involved in my share of it in this industry. I could restrict things to the wins—after all, it’s my book! But I think it’s instructive for people to understand that no matter how successful any investor (pro- fessional or not) is, there are plenty of failures along the way.
I made one of my biggest mistakes in the middle of a hot streak. As I mentioned in the introduction, my forecasts on Microsoft tossed me into the limelight as an analyst somewhat early on. I developed a bit of a following. Soon after Microsoft, I picked my next stock darling—Borland. It’s hard to believe now, but as big as Microsoft was, Borland started out even bigger.
It all began with a recommendation to buy, which I placed on the stock at around $20 a share. The stock shot up to $85 a share in a very short time, maybe a year. As the stock cata- pulted toward that $85 mark, it became somewhat obvious that it had gotten a little ahead of itself. It was overvalued.
The interesting thing was that as Borland climbed closer to $85 per share, more and more analysts started to recom- mend it. Most analysts jumped aboard the recommendation bandwagon when the stock was between 70 and 85.
At the height of the fever, I started to get a little bit ner- vous. I thought about downgrading Borland from a buy to a hold. Even if things played out as I hoped, it seemed that the valuation was getting a little rich. I won’t try to claim that I had any idea at the time that Borland would run into trouble, because I didn’t, but the stock did appear overvalued.
I brought my doubts to a veteran analyst at my firm who said, “We downgraded Wal-Mart, because of similar thinking, before it had run all the way up, and that was the worst mistake we ever made.” As I said, I was the new guy on the block. And listening to this, I thought, “Wow. I don’t want to be the guy who downgraded Wal-Mart.” I held firm.
The Wal-Mart story made me hesitate, but it wasn’t the only reason I didn’t pull out of the stock. The second reason, which is almost embarrassing to admit, was that my report, the
culmination of months of research and analysis, hadn’t come out yet. And I thought, “How can I downgrade Borland when the report is coming out next week?” The third thing stopping me was that I hadn’t yet found out if my thinking was right.
The reason the stock had gone up was because people believed I was right in my analysis of Borland—that once the company shipped its new Windows versions, it would gain more market share. But not enough time had passed to determine for cer- tain whether my predictions were valid.
For me, the whole Borland frenzy culminated at an ana- lyst’s meeting at Borland’s headquarters, in October 1991.
Borland was showing the Windows versions of its Quattro Pro spreadsheet, its new (dBase) database, and its traditional data- base, Paradox. After the demonstration, the Borland people told us that all four products would ship sometime between January and March 1992.
The room started buzzing. It appeared to a lot of us ana- lysts that once Borland shipped these Window versions of its products, the company would be hard to stop. Paradox was sailing along, and Borland had just acquired Ashton Tate (and, thereby, dBase), so now the company had the two domi- nant products in the database arena. Quattro Pro was no slouch—it was already taking market share away from Lotus 1-2-3 on the DOS platform. With the announcement that Win- dows versions were almost ready to be shipped, success seemed assured. The room was in an uproar.
After the meeting, a bunch of analysts got to talking.
There was a feeling of frenzy in the air. All around me, people were whipping out their phones and calling in estimates for Borland’s next fiscal year. I overheard an analyst say her earn- ings estimate was $3.00 per share. A few minutes later, some- one told her that I was at $4.00 per share. She went to the phone immediately and called in a new estimate of $4.00. The bumps fed upon each other. In the few minutes we were sitting there, the stock shot up several more points.
(Continued)
50 the big tech score
As I said, the room was buzzing. Even with expectations high, it looked like an easy win for Borland. All the company had to do was ship its products when it said it was going to ship them. It was a shoo-in situation.
And now we come to why this interlude is attached to the chapter on management. Execution and the ability to execute are as critical as or more critical than any other thing you eval- uate in a company. Failure to execute is what brought the Bor- land house of cards crashing down.
What happened? Nothing drastic. Borland failed to get the Windows versions of its products out when promised. In the interim, Lotus shipped a Windows version of its compet- ing product, 1-2-3. In an odd stroke of luck for Borland and its product Quattro Pro, Lotus’s new version of 1-2-3 was defective. Had Borland shipped Windows versions then, it still could have won the game.
Unfortunately, Borland’s management continued to drag its heels. Tired of waiting, with Lotus 1-2-3 not working prop- erly and Borland’s spreadsheet software not even on the shelves, many Windows customers decided to try out a product that was an underdog at the time—Microsoft Excel—mostly because they had no other choice.
Borland’s tardiness cost it momentum, just as more and more customers were migrating to the Windows platform. At this critical time, Borland stopped gaining market share and started losing it. Plus, the severe delays in release caused another problem: While Borland’s products were being held up, new features were being added to competing products.
Borland’s worries about the need to add these features to its own spreadsheet delayed shipping even further. Risky market- ing and distribution decisions added to the downward spiral.
Once the stock started coming down, I made the mistake of thinking “Well, it’s much cheaper now. How can I down- grade it with those new products right around the corner?” So I stayed with the stock way too long and caused a lot of damage to my career. Some of the portfolio managers who had come to the stock late, when it had already been run up, and had lis-