As people ponder Berkshire Hathaway’s future after Warren Buffett leaves the scene, consider a thought experiment. Suppose Buffett had just turned 45, not 90. Knowing his skills, which companies would be good fits for a younger Buffett as CEO?
Here is the bottom line up front: These will be the highest-quality companies with the highest-quality shareholders.
This experiment is useful to anyone seeking to build or invest in such a company.
A pivotal factor for CEO fit is a match between the executive’s skills and the business’s needs. Capital allocation has been Buffett’s strongest suit at Berkshire Hathaway
and while every company should make capital allocation an explicit operating principle, only a minority do. That narrows down our job search for the younger Buffett.
Another requirement is congruence between the CEO’s values and a company’s prevailing culture. Buffett has prospered in a trust-based culture, where senior managers grant great autonomy, creating a decentralized structure. Given the prevailing command-and-control culture across corporate America, this further winnows the search.
The decisive measure concerns the philosophy of the CEO and that of the shareholders. Today’s dominant shareholder cohorts are indexers and short-term, transient traders. But Buffett cultivated a majority of quality shareholders (QSs), that discerning corps who are picky and patient. Buffett has always known what every venture capitalist will advise: building a great business requires such focused, long-term investors.
At Berkshire, cultivation of such QSs occurs through its celebrated annual meeting and Buffett’s signature shareholder letter, due out this Saturday. Buffett sculpted Berkshire’s shareholder base through the 1996 recapitalization that created Berkshire’s dual class structure, the higher-voting class priced steeply to discourage transient trading and reward long-term thinking.
Which companies, then, stress capital allocation and a trust-based culture while attracting QSs? Using joint rankings in each of these categories, as assembled by the Quality Shareholders Initiative with help from EQX Investor Capital, 15 companies excel. Call them quality companies:
Emerson Electric Co.
Fairfax Financial Holdings
Illinois Tool Works Inc.
Post Holdings Inc.
Roper Technologies Inc.
Excellent insight into these companies are their CEO letters to shareholders and annual meetings. While none reach the gold standard set by Berkshire and Buffett, the letters tend to be widely read and meetings well attended. Through both media, you will find evidence of conscious cultivation of QSs, often by explaining the company’s approach to capital allocation, features of its culture and long-term value creation. A young Buffett would be at home in such places.
Several of these quality companies are in the insurance business, a sector that tends to attract skilled capital allocators who think long-term. Insurance is a trust-based industry, moreover, where policyholders pay premiums based upon their faith in the insurer to honor promises in the distant future.
Those listed own impressive insurance assets—Markel’s brand names, Alleghany’s TransAtlantic Holdings, Canada-based Fairfax’s Allied World—and remarkable non-insurance businesses, ranging from the leader in ornamental plants (Markel) to the iconic Peppa Pig (Alleghany). A young Buffett would love such businesses.
Three quality companies share a common ancestor: the venture capitalist George Ohrstrom (1927-2005) incubated and transformed Carlisle, Dover and Roper. These companies, like Berkshire, buck prevailing fashions by maintaining a diverse collection of business. All use slightly different approaches to managing scale and justifying it, but the unifying traits are trust and a long-term view.
Each quality company has its own method—for example, the Danaher Business System or the ITW Business Model. Illinois Tool Works has usually favored many small acquisitions and leaves management alone while Danaher ultimately made larger acquisitions and uses a rigorous companywide system of management recruitment and training.
In response to activist shareholder pressure, ITW hived off some business in a selective pruning while Danaher has made major spinoffs. But both remain faithful to fundamentals that Buffett would appreciate.
Another recurring theme across these quality companies is lengthy CEO tenures. Prem Watsa has been CEO at Fairfax since 1985, Garry Ridge has run WD-40 since 1997; Shantanu Narayen has been in charge at Adobe since 2007.
Among companies, Alleghany has had five CEOs in 80 years, Emerson Electric has had three CEOs in 66 years, and Amphenol’s current and prior CEO together served 25 years. While none approach that of Buffett at Berkshire—nearly 60 years—a younger Buffett would welcome the chance at such longevity.
But while Buffett would be a good fit running any of these quality companies, let’s conclude this thought experiment by observing that none of them need his help. Not only are they already run by outstanding managers, they became quality companies because their leaders adopted policies that attract quality shareholders.
By the same token, Berkshire is poised to prosper long after Buffett leaves the scene, because he created such an institution and sculpted such a shareholder base. The lesson for other managers is clear: quality begets quality and a clear route to a quality company is by attracting quality shareholders.
Lawrence A. Cunningham is a professor and director of the Quality Shareholders Initiative at George Washington University. His books include “Quality Shareholders,” “Dear Shareholder” and “The Essays of Warren Buffett.” Cunningham owns stock in Berkshire Hathaway and is a shareholder, director and vice chairman of the board of Constellation Software.
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