Understanding Business Strategy When Analyzing Investments

We decided to take a different approach to this month’s commentary and answer a question we often get from clients. They want to know what kind of business strategy we look for when we select stocks for our clients’ portfolios. The following story illustrates a key factor we consider.

Henry Rowan lived in New Jersey, just outside of Philadelphia. After graduating from MIT’s engineering program, he started an industrial furnace company in his garage, turning it into a multinational business and becoming wealthy in the process. He was the classic millionaire next door – drove a pick-up truck, stayed in the same house, and lived a generally unpretentious lifestyle.

At one point a friend of his, the VP of Development at Glassboro State College in New Jersey, asked if Rowan wanted to buy a $1,500 ticket for a raffle to benefit their business school. Rowan proclaimed that the world had enough MBA’s and instead suggested building an engineering school, to which he would contribute $100 million. For a school that had a $780,000 endowment at the time, this was life-changing.

In another world, John Paulson, a successful hedge fund manager from New York, also wanted to invest in educating future engineers. So he gave a gift of $400 million to Harvard for engineering. For Harvard, already with an endowment of $36 billion, this was a welcome surprise.

What’s the difference in the impact between the two donations?

Think about it like this. If you’re the manager for a soccer team and you’re trying to make your team better, what’s the best strategy: upgrading your best player or upgrading your worst player?

Statistical analysis on this subject shows that, in soccer, having your worst player upgraded improves your team more than getting a better star player. This is because soccer is a fundamentally interactive game that is heavily dependent on team members working together. It’s nearly impossible for the best player to win a game on his own.

While this is the case in soccer, basketball is the opposite. If you want to make your basketball team better, you invest in making your best player even better. Michael Jordan, Dirk Nowitzki, and Shaquille O’Neal would definitely attest to that.

Understanding this distinction in strategy between these two games can be carried over to organizations. Depending on the industry and structure of your business, you could be either sport.

Did the industries each businessman made their names in influence their charitable giving decisions?

Paulson, the hedge funder, is clearly in a basketball industry. Because his work values finding the best of the best, it makes sense that he gave all his money to an Ivy League school. Rowan, the furnace builder, was in a soccer industry – he wasn’t interested in the top 1 percent; he was interested in raising the average. This explains why he structured his gift to help lift the tide across the board.

So which one is “right”? It depends.

An example of an ideal “soccer industry” is aviation. While Austin-Bergstrom can be counted to keep flights on time and the traffic flowing, if a bad actor like La Guardia airport, for instance, is behind schedule it can slow everyone down and hurt profits.

An example of a “basketball industry” is newspapers, where most people only read the 1-2 biggest stories. Similarly, in software development, having an elite coder over a several ‘good’ ones can be a game-changer for the company.

For our investments, it really depends on the industry the companies are in as well as where we are in the business cycle. Business cycle is essential to know in order to shape expectations. However, the key take-away is being sure we know which game should be played between soccer and basketball, and making sure the management teams at these companies have that same understanding, and are executing their business strategies accordingly.

This article is based on a speech by Malcolm Gladwell at Charles Schwab Impact 2016.