There’s a famous scene in the movie Patton where the maverick general George Patton looks out at a retreating German army and growls, “Rommel, you magnificent bastard. I read your book!” It always struck me as strange that, before Patton, no-one had successfully used that information against Rommel.
Patton’s line has been playing in my head the past two weeks with the news of Amazon.com’s (AMZN) proposed takeover of Whole Foods Market (WFM). One of the most predictable things about this episode is how quickly sell-side analysts revised their view of WFM, first with the presence of an activist investor (Jana Partners), and then with the AMZN bid. Before Jana’s arrival on the scene, market consensus was that WFM was a struggling grocer, facing an existential threat from lower-priced competitors. Afterwards, it was miraculously a valuable takeover target. So I think I can be forgiven for rolling my eyes at the same sell-side analysts theorizing that WFM might end up in the arms of another bidder, such as Kroger. Anyone paying attention should know that WFM’s CEO, John Mackey, places an unusual emphasis on the company’s culture, and was likely to be extremely picky about his acquirer. And how would they know that? Well, Mackey wrote a book about it.
Yup, in 2013, Mackey and co-author Raj Sisodia wrote a book called Conscious Capitalism. While not exclusively about WFM, the book draws heavily on Mackey’s experience creating the company. His emphasis on creating a different type of business is immediately obvious. With that background information, the notion that he would surrender his jewel to the likes of Kroger seemed utterly far-fetched to me.
This speaks keenly to the ongoing debate about the value of fundamental qualitative analysis. In an age of low-cost passive and quantitative funds, it seems anachronistic to think about things like the quality and motives of a management team. But I think this ignores what we know about competitive advantage. There are generally two ways a company can develop a competitive advantage. The first is to achieve a cost advantage, while the second is to create product differentiation. This framework applies equally to investment firms. While index and quant funds have the cost advantage, Bill Miller laid out several ways an investor could hope to differentiate himself from his peers. According to Miller, informational, analytical or psychological advantages are the keys to outperformance. None of these is easy to achieve. If they were, the advantage they offered would be fleeting. And Nate Chesley of MITIMCo adds a fourth differentiator, structural advantage. This last one shouldn't be underestimated either. After all, the tenets of value investing are timeless, but its payoff is often highly cyclical, which is tough going for both the fund manager and limited partners. Everyone claims to be a long-term, patient capital source, but history shows it just ain't so. Without the right structure and partners, even the most informed, astute and sanguine investor will struggle. With the right backing, though, the investor can look through a company's temporary struggles and appreciate the quality of management and the underlying business.
I'm not saying, by the way, that reading someone's book qualifies as a nuanced analysis of management. CEO hagiography often peaks around the same time as stock prices do. In fact, the release of Mackey’s book coincides almost perfectly with the WFM stock peak in Nov 2013. You'd still be down 35% if you'd bought at the top. But I actually think this proves my point. A skilled analyst understands when stock prices are undervaluing OR overvaluing management. So when a skill is hard, valuable and seemingly out of favour, it appears to be a good time to invest in that very skill.
Writing about entrepreneurs, Mackey and Sisodia wrote, "the really successful ones are...pragmatic, resilient, and uncommonly tenacious. They have the self-confidence and courage to resist the legion of naysayers who are ever present to say, "This will never work."" The same is true of the successful investor.