Checklist series, Part 2: Track record
Is past performance is a clue to the future?
There’s a mandated disclosure in the investment business: “Past performance is not indicative of future results.” This is basically universally true.
It’s also applicable in the world of business, but far less so. Managing investments is unpredictable, and markets can misbehave for extended periods of time, humbling even the best investment managers. But we all know serial entrepreneurs who have the gift of building businesses, and organizations that have a culture that breeds success.
Unlike investing, in business, past success might actually be a pretty good indicator of future success. If a company has maintained consistent revenue or profit growth, or operated with lower debt than the competition, or focused maniacally on the customer experience, you can often assume that this will continue.
Of course, the market knows this, and these high quality companies tend to trade at far richer multiples than the market averages. Often, but not always. You just have to be ready to pounce when they go on sale. And you do this by identifying the best of the best ahead of time.
If there is low management turnover and a well-functioning Board of Directors, a company’s culture can persist far beyond the tenure of current leadership. There are many examples of this, not least of which the company I currently work for, which after 46 years maintains a philosophy and approach that carries on the Founder’s vision. I can’t guarantee investment success, but I can guarantee a consistent approach to building portfolios and serving clients.
A good example of this kind of thinking is Costco1. It’s in the company’s DNA.
“If you raise the price of the hot dog, I will kill you” is Jim Sinegal’s famous stance on holding the line on the Costco food court’s $1.50 dog. It’s not about the hot dog. It’s about how the company treats customers, and how it thinks about pricing. I dare say, decades from now, that philosophy will likely remain embedded in the company’s approach.
When identifying investment targets, I’m looking for companies like this.
Like many of my checklist items, I’ve learned the hard way that it’s easier to bet on things staying the same than it is to anticipate a turnaround.
Because of this, I make it a habit to avoid dumpster diving when it comes to buying stocks. Value investors are attracted to cheap stocks, and often those stocks are cheap for a reason. I’d rather pay a few extra turns on an earnings multiple to buy the best company in an industry rather than get a second-rate competitor for a “cheaper” price. It wasn’t always this way, but I’ve learned too many hard lessons over the years.
All of this information should be reflected in the financial statements. Don’t tell me a company has great brands if it can’t maintain gross margins. Don’t tell me they prioritize shareholder returns when they issue dilutive stock. Don’t tell me you’re a leader in innovation if your R&D spending is lower than your peers.
This is why there is value in reviewing a company’s past financial statements. I’m a big fan of Value Line as a way to get a quick look at a company’s financial history. It’s a great way to see if past results match the story that management has been telling us. Yes, it’s limited in that it’s a look at the past, and when we are buying a stock we are buying future earnings. But one of the assumptions that I make is that the future will look like the past. I won’t always be right, but it’s a higher probability bet than anticipating how things will be different.
A management team that has demonstrated the ability to grow shareholder value over time should be given the benefit of the doubt that they will continue to do so. A company’s track record is an important part of screening for a low-risk investment.
No, I’m not recommending it as an investment. It’s frickin expensive. But what do I know? I’ve been waiting for the opportunity to buy Costco stock for thirty years.