Updated: May 20, 2022
Nobody has been able to nail down whether Albert Einstein in fact described compound interest as one of the great - or even greatest - forces in the universe.
"A company that blatantly puts so little thought into its raison d'etre is unlikely to make a great long-term investment"
Certainly, compounding as a phenomenon is fundamentally embedded in the nature of the universe. And certainly, it can be quite powerful when applied to the financial world, as Jim Collins and Jerry Porras illustrated in their 2004 best seller Built to Last: Successful Habits of Visionary Companies.
The authors – one a consultant, the other a professor - polled 700 CEOs of Fortune 500 and Inc 500 companies, asking them to nominate up to five companies they perceived to be highly visionary. The pair then selected the 18 that received the most mentions.
Looking back, they found that from 1926 to 1990, these 18 companies’ shares averaged a return of 14.4% a year compared with 9.7% for the general market. Impressive on a yearly basis, the difference in returns is stupendous when compounded.
Demonstrating what Einstein meant, US$1 invested in these companies on January 1, 1926 would have been worth US$6,356 dollars at the end of 1990, compared with US$415 dollars for an equivalent investment in the general market - the five of the 18 firms founded after 1926 were added into the equation as and when they became listed.
So, as a shareholder, how do you identify companies that can churn out these kinds of long-term returns?
To identify the traits that set these 18 apart, Collins and Porras compared each of them with their respective number twos. What the authors found was that the main distinction compared with their main rivals - apart from the fact that the aforementioned US$1 invested in the comparison firms would have turned into only US$955 dollars - 11.1% per annum - was that the visionary companies had a clearly articulated ideology, a set of values for which they stood.
These values are not to be confused with business objectives. To do this would be to confound a belief in God with the need to build a new roof for the place of worship. No. These values create the cult that drives management and employees to excel.
Take the example of visionary Hewlett Packard and its comparison firm Texas Instruments. HP's fifth and final core value refers to profit and growth but only insofar as they make the first four - relating to technology, employees, community, and affordable quality - possible. Collins and Porras found no statements by Texas Instruments to suggest that it existed for reasons beyond making money.
Indeed, what was instructive about the Collins and Porras study was that none of the visionary companies - which also included Procter and Gamble, Philip Morris, and Johnson and Johnson - listed maximisation of shareholder wealth as one of their top values.
Of course, it is not enough simply to articulate an ideology in writing. One has also to convey it to employees and ensure that it is both understood and applied. Jim Burke, Johnson and Johnson's chief executive in the 1980s, estimated that he spent 40% of his time on the job communicating the company’ credo to his employees.
Another of the 18, Merck, put into practice its ideologies of preserving and improving mankind and corporate social responsibility by developing and giving away free Mectizan, a drug to cure river blindness, to millions in the developing world.
Before you go trawling annual reports for lists of core values, a word of warning: it's much easier to pinch generic statements from someone else and stick them at the front of your annual report than it is to put some deep thought into what your company really stands for and then to communicate this doctrine to your employees.
A good example of this is Informatics, a once well-regarded Singapore listed company that hit troubles in recent years.
The first page of its 2002 annual report included ambitious phrases such as, Becoming a Global Leader by Exceeding Customer Expectations. These were followed on page 2 by nine- yes, nine! - core values including, We Manifest Speed in Every One of our Actions.
While there may be no direct causal link between these inane statements and Informatics’ demise it seems clear that a company that blatantly puts so little thought into its raison d'etre, and gets its audience confused, is unlikely to make a great long-term investment.
On the other side there is Li and Fung, the Hong Kong listed company that stands out over the past 15 years as one that successfully made the transition from small local company to large global player. Is there any evidence it has a core set of values that enabled its extraordinary growth?
The first good sign is that there is no explicit mention of core values, visions, and missions in its annual reports, suggesting that the Fung brothers know their audience.
And elsewhere? Much can be learned about the firm from an interview by celebrated strategy consultant Joan Magretta with chairman Victor Fung in the September- October 1998 Harvard Business Review.
In it, Mr Fung said, “As we have transformed a family business into a modern one, we have tried to preserve the best of what my father and grandfather created...If I had to capture it in one phrase, it would be this: think like a big company, act like a small one.
Li and Fung hires entrepreneurs to manage each of its divisions, then gives them a great deal of autonomy. As Mr Fung said of these managers, “We sometimes call them little John Wayne's because the image of a guy standing in the middle of the wagon train shooting at all the bad guys seems to fit.”
And had you been investing in the company over the past decade, you too would have made a killing.
Published in the South China Morning Post
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.