Good to Great Companies

1. Good to Great Companies Picking Great Companies to Build the Greatest Portfolio and Using Such Techniques to Make You a Great Executive Eric Borzino, 4/11/2005

2. Today’s Objectives • Show how an avg person can use non-financial techniques to pick great long-term holds • Prove that “change” that leads to sustained stock gains cannot be pinpointed in a “great” company • Are you investing in hedgehogs or foxes? • Will YOU be a hedgehog or fox? • These tips to identify companies are also applicable to YOUR future management careers

3. Jim Collins • Not as much of an idol as Peter Lynch • Author of fine and popular books as Built to Last and Good to Great • Taught at Stanford’s Graduate School of Business • Founded his management research laboratory back home in Boulder

4. Collins’ Laboratory Results • Started with 1,435 good companies • Found the companies that became great based on certain criteria over 40 year performance • Company had to show good stock performance, capped with a transition point • After transition, company had to generate stock returns that exceeded general market at least 3 times over 15 years independent of industry

5. Being Good, Ain’t Good Enough • Vast majority of good companies remain just that – good, not great • 11 “great” companies were identified • $1 invested in the general market since 1970 would yield $56 by year 2000 • $1 invested evenly upon the 11 great companies would have yielded $471 by year 2000 • All 11 companies had decent performance, until a transition occurred

6. 11 “Great” Companies • A few of the companies over the past 15 years that have been identified as great: • Abbot • Circuit City • Fannie Mae • Gillette • Kimberly-Clark • Wells Fargo • Walgreens • Philip Morris • Kroger • Nucor • Pitney Bowes

7. What factors do not lead to greatness? • Larger-than-life celebrity leaders • Negative correlation • 10 of the 11 good to great CEOs came from the firm • Good to great companies did not principally focus on what to do to become great • Equally focused on what NOT to do • And also what to STOP doing – diworsification • Technology can accelerate a transformation, but cannot cause a transformation

8. What factors do not lead to greatness – Part Duex? • M&A played no role in igniting a transformation from good to great • Two big ok companies joined together NEVER make one great company • Sorry Sat for bursting the bubble • Good to great companies had no specific action or program to signify their transformations • Only in retrospect did the magnitude appear • No outlandish, over published event or change • Good to great companies were not in great industries, some were in terrible industries

9. The Flywheel Cycle to Greatness • Level 5 leadership • First who…then what • Confront the brutal facts • Hedgehog concept • Culture of discipline • Technology accelerators People Buildup Thought Break- Through Action

10. Be Humble Yet Cool • There are five levels of leaders • Level 5 leaders, had one distinguishing characteristic: humility • Level 5 leaders channel their ego needs away from themselves • Larger goal is building a great company • Ambition is first and foremost for the institution, not themselves • Extreme blends of humility and intense will

11. Egos Can Kill • Absence of Level 5 leaders was the consistent factor that hindered greatness • Level 5 leaders set up successors for success • Other level leaders set up their successors for failure • Or chose weak successors • Good to great leaders never wanted to be larger-than life • Ordinary people producing extraordinary results due to unwavering resolve to produce sustained results • Large personal egos contributed to the demise or continued mediocrity of 2/3rd of comps

12. Are You Level 5 Worthy? • Abraham Lincoln • Personal modest and shy nature • Weren’t signs of weakness • Darwin Smith – CEO of Kimberly Clark 1971 • Generated stock returns 4.1 times the market • Demolished rivals Scott Paper and P&G • Resolve to do what’s best for company: sold the paper mills to concentrate on consumer products • Wall Street called the move stupid – downgraded • “I never stopped trying to become qualified for the job”

13. Great, How Do You Find 5spot? • If you listen to a CEO and he boosts of how his new ideas/programs will enhance returns • Or how his strategies have already enhanced returns • AVOID – got an ego and wants credit • Level 5 leaders look outside the window to accredit • Thanked others and luck • Also never blamed bad luck when things when poorly, took credit for mistakes (unlike other leaders)

14. The Flywheel Cycle to Greatness • Level 5 leadership • First who…then what • Confront the brutal facts • Hedgehog concept • Culture of discipline • Technology accelerators People Buildup Thought Break- Through Action

15. First Who NOT What • Began achieving sustained success by first getting the right people on the bus • Get the wrong people off the bus • Then, figured out where to drive it

16. Isn’t Strategy and Product Mas Importante? • Why do it this way? • Begin with “who” instead of “what, can more easily adapt to a changing world • If you have the right people on the bus, problem of motivation and people managing are diminished • If you have the wrong people, doesn’t matter whether you have the right direction b/c company will still not be great

17. Teamwork Baby • Good to great companies build deep and strong executive teams • Decent companies followed a “genius” with a “thousand helpers” • What happens if genius is wrong or leaves? Idiots… • People are NOT your most important asset. The RIGHT people are. • Look for companies with distinguished managers who have been in the company and work together over time

18. Wells Fargo’s Success • Early 1970s, then CEO Dick Cooley foresaw changes in the banking world, but did not know what or how • Assembled an endless stream of talent – best team according to Warren Buffet • Hired outstanding people whenever and wherever without a specific job in mind

19. The Flywheel Cycle to Greatness • Level 5 leadership • First who…then what • Confront the brutal facts • Hedgehog concept • Culture of discipline • Technology accelerators People Buildup Thought Break- Through Action

20. Who Says Honor Doesn’t Matter • All good to great managers first confronted the brutal facts of their current reality • Impossible to make good decisions without being honest in the process • Look for executives who admit to the reality of their industry – company to invest in • Comparison companies were afraid to confront adversity, not the good to great companies

21. Got to Stay Stiff and Hard • Stockdale Paradox: • Absolute faith that you can and will prevail in the end • Same time, confront the most brutal facts of your current reality • Leadership does not begin just with vision, begins with the right people confronting reality and sticking to a rigorous yet flexible plan

22. The Flywheel Cycle to Greatness • Level 5 leadership • First who…then what • Confront the brutal facts • Hedgehog concept • Culture of discipline • Technology accelerators People Buildup Thought Break- Through Action

23. The Hedgehog and the Fox • Ancient Greek parable: • The fox knows many things • The hedgehog knows one big thing • Foxes pursue many ends and see the world in all of its complexity • Hedgehogs simplify the world into a basic principle, see what’s essential, and ignore the rest

24. The Big Three • All good to great companies adhered to the Hedgehog Concept (three questions) • What you can be the best in the world at • What drives your economic engine • What are you deeply passionate about • Not the goal to be the best, but understanding of what you can be the best at

25. Sometimes Need to Rethink • If you cannot be the best in the world at your core business, then your core business cannot form the basis of your Hedgehog concept • Best to look for companies that keep it simple • Exotic companies in many different industries are like the fox and stretch themselves too thin • As a manager, want to focus solely on your core and how to make it the best in the world

26. What the Hell You Saying? • Takeaways for investing: • Look for companies with humble, yet passionate leaders • Research the background of management to determine if the team was assembled with a “who” instead of “what” mentality • Find out the culture of the firm, whether it is bureaucratic, dominated by a few executives, or open and willing to confront the brutal facts • Keep an eye out for simple companies, with great people, hard-working culture, and not constantly featured in CNBC or Wall Street Journal

27. Hedgehog Concept Most Important • To remain great over time requires to strictly adhere to the Hedgehog Concept • If the firm slides outside its hole, it will slide back down to mediocrity • Good to great transformations never happen at once, unlike the WSJ likes to make it appear • Happens slowly over time • And can easily be tracked by looking at qualitative clues outside of ratios and DCFs