Active management and the CEO interview

Okay, so let's move into the Oakmark criteria. If you followed Oakmark, you've seen, seen us cite these three things frequently, and this is something that we look for in every company we consider investing in. 

First, we want to significant discount to our estimate of intrinsic. To us, that means what is the price that an all-cash buyer could pay for the business and still earn a reasonable return.

Second, we try to stay away from value traps by only buying companies where we expect per share value growth to at least match what we expect from the S&P 500.

And third, we talk about investing with management teams that think and act like owners. We always talk about that as our third criteria, but it does not mean it's the least important to the three. In fact, in a lot of ways, it is the most important, and it's probably the one we talk about the least. So let's go into that a little bit.

First, we want to see management incentives that align with the shareholders. So when we look at management compensation plans, and other incentive pay, we, we want metrics that have denominators. So not just what is net income, but what is net income per share: how much of sales grown, how much of sales per share grown? Things that have, like return on invested capital. Those are the metrics that we think better align with the shareholder outcome, and we want management incentives to be consistent with what shareholders benefit from.

Now you could say that morally management should always be doing what's in the interest of the shareholders, and that's true, but we're more comfortable if they're also economically aligned with us. So that if they're doing, if they're taking the steps to maximize their own economics, that's also what's maximizing shareholder economics.

Second, we want to see CEOs that have a history of success, not only at the company that they're currently with, but in any prior situations. We love to see, CEOs that have done things that are clearly in the shareholder interests that might not be in the interest of maximizing their own pay as CEO. Things like selling off divisions that might be worth more to another company, because they're a strategic fit for that company. Or share repurchase. Share purchases decreasing the size of, of the capitalization of the company, but done so in a way that improves the economics per share economics for the shareholders. CEOs always want to get bigger, that the bigger their kingdom generally the larger they're pay, but it's important to us that they focus this on a per-share basis.

And then last, we want to decide whether or not the CEO is a person that we want to bet on. Is this somebody that we think has a better than average chance of winning and are they aligned with us? And that's where CEO interview questions become so important. So when we interview a CEO, we want our analysts to understand how fortunate we are, that a CEO has allocated an hour of their time to get to know us and for us to get to know. We don't want to follow a script. We don't want to ask questions that have publicly been answered already. We don't want to ask questions that could be answered by the CFO or the investor relations team.

And last we don't want to focus on refining our model. One of my pet peeves is when you've got the CEO sitting across the table from you and the analyst is focused on whether or not five-year out operating margins are more likely to be sixteen percent or sixteen point four percent. That's not what we're trying to accomplish during this interview. So focusing on the positive, what we do want to accomplish.

First, we want to show that we're well prepared. We find these interviews go very differently when the CEO has gains our respect early on by seeing how well prepared we are. So we want the analysts to have gone through all the public presentations, conference call, transcripts, any podcasts the CEO has done, and then we'll ask questions that show that we have done that prep work. Second, we want to focus more on the individual than the company. There's a lot that's public that we can learn about the company and most of our questions about the business can be answered by someone else inside the company. But we want to know who is this person that's leading the company today, and is it somebody that we want to be betting on or not? So we ask questions about background before they got to the current role, what prepared them for it. How did they decide this was a position they wanted? What skill set do they bring to the table that will allow them to succeed in this job? We want to know what they think success will look like. Very open-ended question and we get a very wide range of answers to that question.

But it's important to us that if we're betting on someone that we think will have the ability to succeed, that they define success in a way that's similar to how we would define it as an outside shareholder. We want to understand the relationship they have with the board. It's important to us that the board be viewed as an asset. Sort of like consultants to be utilized.

In areas where the CEO might not see the, it might be able to fill in gaps from where the CEO would say that's not really their strongest suit that there's someone on the board that can kind of fill that, that hole for them. And then last, we, we wanna understand what kind of tenure the CEO expects to have.

Just the nature of the business CEOs of large companies tend to be in the second half of their career. And we we wanna understand whether it's the seventh inning or we're in the ninth inning because CEO transitions are an incremental risk in an investment, and if we're facing that risk, we want to make sure we're getting paid for it.