How Jim Collins Can Make You a Better Investor – Understanding Core Ideology

by Geoff Gannon


Quan here.

Geoff usually tells me that Jim Collins’s books are among the best investment books. This is the reason I have read Jim Collins’s books at least twice. For those who don’t know – Jim Collins  is the author of books like:

In this series, I will talk about how I think investors can apply some of Jim Collins’s ideas to become better investors.

This first article is about the most important finding in Built to Last: Core Ideology.

Built to Last is the least shareholder-centric of Jim Collins’s book. It has a problem in its research sample, which includes companies that last a long time and gain the respect of their industry peers but are not necessarily successful stocks. Actually, most of the ideas in Built to Last are more about how to build a company that would last forever than about what separates a good business from a bad business. Lasting forever might be of the least importance to investors. For example, you could have bought Gillette in 1989, the year Warren Buffett bought the company’s convertible preferred security, and held until the company was sold to Procter & Gamble (PG). You would have made a handsome return. So failure to continue as an independent company does not always mean failure to perform well as an invesmtnet.

Ironically, the idea in the book that seems to be the most hostile to shareholders turns out to be the one that is most relevant to investors.

 

The Best Companies Have Strong Core Ideologies – But Know They Need Profits Too

The idea is about core ideology, which includes core value (a company’s essential and enduring tenets) and core purpose (reasons for existence beyond profit). Basically, Jim Collins found the existence of core ideology in his visionary companies, and “maximizing shareholder wealth” is not the driving force throughout the history of visionary companies. Visionary companies exist for something beyond profit. That sounds theoretical but I think there are three main reasons that core ideology can contribute to long-term financial success of a company, which makes it worthy of attention from investors.

First, something beyond profit making will give a company the internal drive to find new products to grow. When an organization is full of people striving for a goal, there will result constant initiatives to fulfill the goal. In business, the result would be ideas about new products or services.

We should be cautious of companies that try a lot of things and expand into unrelated areas. However, looking for ways to serve a purpose will keep companies from straying out of their circle of competence. And trying a lot of things in a disciplined way is an attractive trait. But that is a topic for another day.

Why do we, value investors, need to care about the ability of a company to find new products/services? Especially when we can sometimes buy a company with a single product like Coca-Cola (KO) at an attractive price? We do not need to, but isn’t buying a company with ability to find new long-term source of earnings, without paying premium for that ability, more attractive? As long as we keep margin of safety in mind, buying disciplined companies with an internal drive to grow will bring great returns. Moreover, for Phil Fisher-type investors, looking at a company’s ideology might be useful in answering his question #2 about the determination to develop new products.

To take some examples from the book, the core purpose of Walt Disney (DIS), which is “to bring happiness to millions” was the driving force for the company’s numerous ventures beyond making animated movies like family movies, consumer products, theme parks, etc. For Nordstrom where customer service is important, core value like “service to customer above all else” is critical to keeping the company’s policies consistent and to continuous improvements, which would help the company grow in its niche and improve its reputation. Another example is Nintendo (NTDOY). This is a company that had an impressive record of more than 30 straight years of profits until it lost money this past year. Standing behind Nintendo’s success was its purpose to produce fun products using simple technology that make customers smile. If you read the book Nintendo Magic, you will see how important this conviction was in the invention of new games throughout the company’s history. And during a period of crisis when the company got into the technology race to produce high-end technology products, it was the company’s core ideology that guided them through the crisis by turning back to making casual games that bring smiles to all people regardless of age, gender or gaming experience, which led to the introduction of Nintendo DS and Wii that helped the company gain back its leadership. This is not to say Nintendo is a good investment today. This is just an example of how core ideology is important in exploring new products as well as during a crisis.

 

A Strong Ideology Helps Companies Make Short-Term Trade Offs For Long-Term Profits

All this discussion sounds theoretical but not quite if we look at how companies can arrive at their own core ideology. A group of founders sharing a common goal, belief or whatever together starts up a company. They might not notice at first, but one day, perhaps due to success or crisis, they sit down and contemplate about what they have been doing, and condense all their thoughts into a set of principles. From then on, they focus on creating mechanisms that preserve and stimulate the core ideology, from recruitment to propaganda within the organization. Perhaps that is why it is not a coincidence that Jim Collins found the existence of core ideology in all visionary companies.

Second, core ideology helps to enforce long-term thinking. “Maximizing shareholder wealth” is hard to measure. We tend to confuse short-term profit maximization with maximizing shareholder wealth, and many times we cannot see an initiative as profit maximization without hindsight. Back in 2008, Reed Hastings of Netflix (NFLX) was harshly criticized by shareholders for his investment in building the internet subscription service and to bring Netflix streaming capabilities to as many devices as possible. Too much obsession with profit making may condition management into short-term thinking. We tend to get best results when we are not too obsessive with our goals, and think out of the box. Similarly in business, looking at something beyond profit may incidentally maximize long-term profit as long as core ideology does not conflict with profit making. Actually, visionary companies see profit as a means to achieve their purpose. Profit is the blood for them to live by their ideology. For example, David Packard made it clear that because profit enables HP to pursue broader aims: “anyone who cannot accept profit as one of the most important objectives of this company has no place either now or in the future on the management team of this company.”  

Or in the case of Motorola:

“The purpose of Motorola is to honorably serve the community by providing products and services of superior quality at a fair price to our customers; to do this so as to earn an adequate profit which is required for the enterprise to grow, and by so doing provide the opportunity for our employees and shareholders to achieve their reasonable personal objectives.”

Therefore, I am totally fine with a company saying that the shareholder is not its first priority, providing that the company does not forget profit. Besides, core ideology can be used as the ground to protect management from pressure against their long-term initiatives. My advice here is to look at core ideology to detect any conflict with profit-making. I would be very interested in companies with a strong core ideology who still see profit as their blood.

 

An Indoctrinated Worker is a Productive Worker – And a Company is Like a Cult

The third reason is that core ideology can make employees happy and loyal, which helps to boost productivity. Having employees who work only for money is actually a problem for a company. It means the company has no competitive advantage in attracting and retaining talent and it has to match whatever its competitors are offering its talents or let them go. There needs to be something that bonds employees to the company, and nothing fulfills this job better than having an ideology deeply indoctrinated in the employees. People are happier when they think they are working for a great cause they believe in. This also increases switching costs for employees. Indoctrinating an ideology is not easy, and preserving core ideology usually starts from recruitment.

Back to our discussion on the benefits of having an ideology ingrained in employees, the company will not simply get 8 hours of labor per employee per day. Employees will spend more time of their days thinking about new products or processes to improve sales, productivity, etc. As a result, productivity is boosted to a great extent.

My example is again Nintendo. Their employees are constantly chased by other competitors, but they prefer Nintendo-ness to higher salaries. Moreover, it is mentioned in Nintendo Magic that even janitors contribute ideas to new fun games.

I think looking at core ideology is also useful in answering Phil Fisher’s question #3 (about the effectiveness of R&D) and #7 (about labor and personnel relations).

 

Strong Ideology Means a More Consistent Company – and a Simpler Stock to Analyze

Overall, core ideology helps to enforce long-term thinking, improve employee productivity and loyalty, and serves as the building material of corporate DNA that regulates a company’s evolution. Looking at core ideology will give investors some information to answer Phil Fisher’s questions #2, #3, and #7. Even for investors who are more interested in statistics like low P/B, low P/E, core ideology is worth looking at because companies with a core ideology are more predictable. They will not waste money in risky ventures in unrelated areas; and compared to companies without an ideology, without a soul, their past earnings are more relevant benchmarks for future earnings because their actions are more consistent.

Talk to Quan about How Jim Collins Can Make You a Better Investor