“The Key to This Investment is Management.” Really?

by Tim Adler | 03/19/2021 5:17 PM
“The Key to This Investment is Management.” Really?

If human capital, like all other capital, ultimately finds the highest possible payoff, Goldman Sachs may very well be the most precious brain trust in the history of money.

And the market is having none of it. The stock trades at 8.9X next year’s expected earnings, struggles to match the firm’s book value, and has lagged the S&P 500 Index by 400 basis points annually over the last 10 years. 

The reason seems simple. In the financial sector, best on the block is still ugly.  Goldman has returned less than 10% on its equity and 1% on its assets 9 of the last 10 years, and the market is saying to expect more of the same. 

The subtext is, the best and brightest are simply no match for the cyclical, secular, competitive and regulatory pressures which afflict Wall Street year in, year out.  Better to accept the limitations of Goldman’s human capital than to bet on its intellectual prowess.

This kind of boilerplate half-truth should satisfy no one because days like January 26th present another truth: Goldman’s stock price is under constant siege by a reputational wrecking ball.

On that day, buck passing got a long overdue update, as 10 million of them stopped at the desk of Goldman CEO David Solomon — his contribution to the almost $3 billion the firm had recently coughed up for its part in the Malaysian bribery scandal. 

He bore his people’s sins. Call that the price of leadership when you preside over part of the hornet’s nest of bad judgment, poor decisions, and abandoned ethics that has plagued Wall Street forever. Call the $3 billion a cost of doing business under these conditions.

Prospectively, the damage we can do is open-ended, making the financial exposure that investors cannot see, but which they know is out there, the value-destroyer that it is. Whatever Goldman Sachs stock should be worth, knock some amount right off the top for this unspecified liability.

The message that Goldman’s stock price expresses should now be clear. Our limitations may defeat our ambitions, but our vagaries drag us down. We are NOT Cyborgs. We ARE endlessly needy, greedy, capricious, and tempted.

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With this sobering report card for human capital, perhaps it’s time we deconstructed such well-worn bits of earnestness from wealth advisors as “…the key to this fund’s performance is smart company managements,” “…the fund’s strategy is to pick great managements,” and my favorite, “…it’s a Buffet strategy. They own great managements.”

To be sure, nothing tops buying Apple at $4.00 and letting Steve Jobs work his magic, but if that choice is so obvious, the stock cannot be $4.00. And remember, the word is “strategy,” meaning a methodology for replicating results. 

So, unless your advisor can tell you how, exactly, a fund manager goes about finding needles in haystacks, and enough of them to matter, he is not offering a strategy for investing in great managements.

He is offering wishful thinking. Unfortunately, after Apple at $4.00, the opportunities to invest with great managements only become more elusive, for 3 reasons.

First, they must satisfy the joint conditions of great management and great opportunity: Jobs + iPhone = home run of the century. 

Second, their path to success winds through the same minefield all companies must navigate.  Great managements cannot turn rain into sunshine, Disney cannot cure Covid-19, and Goldman Sachs cannot reverse a recession.

Third, often the extraordinary turn out to be just ordinary. Or worse. Years ago, my boss challenged me to find a single chink in the armor of Toys R Us. That was right before the internet ran over them. 

Regardless of the company, easy labels like "great management" numb us to these considerations, which is no way to be. Once we abandon critical thinking, we have lost our last line of defense against investments in ticking timebombs.

Here’s a naughty solution: ditch the big fees and fancy multiples for access to great managements. You care only that managements follow the Hippocratic Oath - first, do no harm. Minimal assurance that today’s David Solomon is not tomorrow’s Dick Fuld.

Turn your attention to funds which invest in companies with multiple paths to victory, none of which rely on management pulling a rabbit out of a hat. Companies whose key assets are machines, perhaps, rather than people who are supposed to act like machines.

Or consider funds comprised of stocks which reflect minimal expectations for the businesses. The technical term for these stocks is beaten-up dreck. Any sign of business improvement sparks a ferocious rally in them, whether management is awake or asleep.

This has been your Investor Advocate, telling you like it is, and…out.

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