What, exactly, is a CEOâs job?
It seems like a simple question. Maybe you even have a simple answer for it.
Yes, the buck stops at the big desk in the corner office. Thatâs true.
So âeverythingâ might be a good answer.
Or, if youâre focussed on activity and outcomes, perhaps âresultsâ would be more fitting.
And they certainly get hired and fired (and sometimes paid obscene bonuses) on that basis, so itâs not wrong.
But if you were a board member of an Australian public company, or its Chair, what would you want the CEO to actually spend her time doing?
As a long-term investor, and someone who hopes to hold my shares for years (and hopefully decades) to come, I care about this quarterâs results.
A bit.
But I care far more about what the CEO is building.
How are they setting the company up for long term success?
And in that vein, I reckon a company board should be focused on the CEOâs responsibility for three things:
— Culture
— Hiring; and
— Capital allocation
No, not necessarily in that order, but I donât think we need to get caught up in trying to force-rank just three items.
Letâs start with culture.
I agree with management guru Peter Drucker that âculture eats strategy for breakfastâ.
Culture underpins how a company operates, what it does and how its people usually behave. There is no one-size-fits-all answer to the ârightâ culture, by the way, but getting it right is important.
The mafia (reportedly) has a very strong culture. So does Surf Life Saving. It binds people together, tells them whatâs expected and valued, and helps everyone pull in the same direction.
Hiring is both more important than, but also a proxy for, results. The CEO canât make all of the sales calls. Canât approve every marketing program. And doesnât stand on the factory floor, running quality control.
She has people to do that.
And itâs the quality of those people that she should be focused on. Are the right people, with the right skills, abilities and experiences, in the right chairs?
Or, as Jim Collins wrote, in what I think is the best business management book ever, Good To Great:
âIf we get the right people on the bus, the right people in the right seats, and the wrong people off the bus, then we’ll figure out how to take it someplace great.â
So hiring (and firing) rather than short-term results, should be a key focus. Get the people right and the results have a very good chance of following.
And then we have capital allocation.
Itâs probably the most underappreciated role a CEO has.
Itâs hard to see. Hard to (truly) evaluate.
Huh? Hard to evaluate? Isnât that why we have a set of financial statements?
Well yes⦠but it only tells you so much.
It doesnât tell you what deals she passed up. It doesnât tell you what would have happened otherwise.
(As humans, we focus way too much on âactiveâ decisions â where something is âdoneâ â and ignore passive decisions (or non-decisions), which can be just as, or more, impactful. But thatâs a topic for another day).
But however you measure it â or broadly assess it â capital allocation is a vital part of the CEOâs remit.
Consider these examples:
Every dollar invested in an activity or asset could have been invested elsewhere, or returned to shareholders.
A dividend paid, when there are growth options elsewhere, means less value is created (see: Berkshire Hathaway â I own shares, for the record).
Or, a dividend not paid, and instead used for a bad acquisition, can destroy huge amounts of value (Isentiaâs purchase of King Content might be an example).
Should they build a new plant, which is cheaper, per-unit, and tie up huge amounts of shareholder capital, or pay a little more for each widget, and buy them from someone else, freeing up valuable capital?
How much should we borrow, and how much of the companyâs cash should we use? The former is cheaper, but riskier. The latter is safer, but weighs on returns.
You get the gist.
But thereâs something else â something I want to focus on for just a minute.
Shares.
Specifically, the companyâs own shares.
Every time a CEO issues more shares â executive remuneration, as âcurrencyâ for an acquisition, or even through a dividend reinvestment plan â we each own a little less than we did before.
For what benefit? Well, that depends.
Sometimes the shares are used judiciously. Other times, well, the CEO and board seem to neither know, nor care.
Block Inc (ASX: SQ2) (nee Square) seems to have done a brilliant deal using then-very expensive shares to buy Afterpay. The deal was done at around US$250 per Block share. They now trade for US$88 â just over one-third of that price. Put another way, Block would have had to issue three times as many new shares at US$88 than they did at US$250.
(Of course, many say Afterpay shares were similarly overvalued at that point, too, so perhaps thereâs some poetic justice⦠but thatâs another one for another day!)
On the other hand, there are companies now entertaining takeover offers at share prices lower than they have been in the past.
Now, if these offers truly represent compelling value â enough that a CEO and board would recommend we take them â why wasnât management shopping the company around at higher prices?
One example is this morningâs announcement of a ‘takeover offer’ for aerial imaging company Nearmap.
The shares closed on Friday at $1.51.
The takeover offer â well, âa non-binding indication of interestâ â is at $2.10 per share.
Good huh?
Well, the shares traded for $4.12 a piece back in 2019.
And at or around $2.10 for most of 2021.
No deal was done.
But now, $2.10 is a good price?
Frankly, it may well be.
Perhaps the business has deteriorated.
Maybe the market interest in this sort of business has softened to the point that $2.10 is the best thatâs likely to be on offer.
But itâs worth wondering why theyâd do this deal, at this price, at this time, but not another deal at a higher price in the past.
Without being on the inside, itâs hard to pass judgment.
But you can see how and why capital allocation matters.
If Nearmap Ltd (ASX: NEA) get this right, it will create real value for shareholders.
If they get it wrong, shareholders can rightly wonder why theyâre doing this deal at this price, rather than shopping the company around somewhere north of $3.
Hindsight bias?
I guess.
But itâs worth asking what a business might be worth in future.
Qantas Airways Limited (ASX: QAN) famously knocked back a bid at $5.45 in 2007 (the bid went ahead, but failed to achieve majority shareholder acceptance).
And in 2022?
The shares are trading at $4.68
Even pre-COVID, at a – very brief – high of $7.35, the gain since 2007 was less than 2.5% per annum.
On the flipside, back in 2002, Yahoo! had the chance to buy Google for US$1 billion. The former is now a shell of its old self and the latter â I own shares in its parent company, Alphabet â is now worth US$1.59 trillion (that’s US$1,590 billion)!
Yes, predictions are hard. Especially about the future.
But you can see just why those capital allocation decisions are so important.
Yahoo! should have done that deal.
Afterpay shareholders should be happy about the price they got, but less so if they held onto their new Square shares, rather than selling for cash.
Meanwhile, Block shareholders should be pretty happy about the price they got for Afterpay, at least measured in their own shares.
Fairfax Media Limited (ASX: FXJ) should have bought Seek Limited (ASX: SEK) when it had the chance.
AMP Ltd (ASX: AMP) should have sold itself to almost anyone at almost any point over the last 20 years, so terrible has been the value destruction in the meantime.
CEOs (and their boards) should always have a strong view about the approximate underlying value of their companyâs shares.
If the shares get too cheap, they should use company money (if they have it â another capital allocation choice!) to buy back those undervalued shares, creating value for continuing shareholders.
If the shares get too expensive, they should be looking for opportunities to sell the company, to issue more shares to raise cash, or to use those overvalued shares to make an acquisition.
But, just like those of us who invest in their companies, they shouldnât be letting the market tell them what their shares are actually worth.
For CEOs, as for investors, the market is there to serve us, not to inform us, as Warren Buffett says.
If they get the price wrong, all of the hard work done to build a great business can be for (almost) naught.
Is your CEO up to scratch on capital allocation? It’s a question worth asking.
Fool on!
The post An ASX CEO’s three most important jobs appeared first on The Motley Fool Australia.
When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for over ten years has provided thousands of paying members with stock picks that have doubled, tripled or even more.* Scott just revealed what he believes could be the “five best ASX stocks” for investors to buy right now. These stocks are trading at near dirt-cheap prices and Scott thinks they could be great buys right now
See The 5 Stocks
*Returns as of August 4 2022
(function() {
function setButtonColorDefaults(param, property, defaultValue) {
if( !param || !param.includes(‘#’)) {
var button = document.getElementsByClassName(“pitch-snippet”)[0].getElementsByClassName(“pitch-button”)[0];
button.style[property] = defaultValue;
}
}
setButtonColorDefaults(“#43B02A”, ‘background’, ‘#5FA85D’);
setButtonColorDefaults(“#43B02A”, ‘border-color’, ‘#43A24A’);
setButtonColorDefaults(“#fff”, ‘color’, ‘#fff’);
})()
More reading
Motley Fool contributor Scott Phillips has positions in Berkshire Hathaway (B shares). The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Berkshire Hathaway (B shares), Block, Inc., and Nearmap Ltd. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has recommended the following options: long January 2023 $200 calls on Berkshire Hathaway (B shares), short January 2023 $200 puts on Berkshire Hathaway (B shares), and short January 2023 $265 calls on Berkshire Hathaway (B shares). The Motley Fool Australia has positions in and has recommended Block, Inc. and Nearmap Ltd. The Motley Fool Australia has recommended Berkshire Hathaway (B shares) and SEEK Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
from The Motley Fool Australia https://ift.tt/VYoQRmT
