Book review - The Outsiders
Aug 19, 2017

The Outsiders

The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success by William N. Thorndike started as a series of biographical sketches that the author gave at his firm’s conference on CEOs that achieved exceptional results during their tenures. Published in 2012, the book expands on those sketches and traces common themes across the eight CEOs profiled. The result is amazing insight into the minds of these CEOs and what traits made them stand out from their conventional peers - in other words, what made them “outsider” CEOs.

Thorndike’s criteria for CEOs to qualify as an outsider: their stock price returns had to perform better relative to the S&P 500 index than GE CEO Jack Welch (3.3x) and also generate significantly better returns than their peer group. Apart from Warren Buffet, the CEOs are not well known to the average citizen of today. They were not considered high profile CEOs like Jeff Bezos or Elon Musk, but they were laser focused on doing their job well and achieved performance that was anything but normal.

Master capital allocators

capital allocation is investment, and as a result all CEOs are both capital allocators and investors. In fact, this role just might be the most important responsibility any CEO has, and yet despite its importance, there are no courses on capital allocation at the top business schools. (location 115)

The strongest theme Thorndike found in common among the eight CEOs was that they were all extraordinary capital allocators. Capital allocation is the process of deciding how to deploy the firm’s resources to earn the best possible return for shareholders.

Thorndike lists the five essential choices that CEOs have for deploying capital:

  • investing in existing operations
  • acquiring other businesses
  • issuing dividends
  • paying down debt
  • repurchasing stock

And the three alternatives for raising capital:

  • tapping internal cash flow
  • issuing debt
  • raising equity

He states that over the long term, returns for shareholders are determined by the choices CEOs make regarding which tools to use to deploy and raise capital. The outsider CEOs were all master capital allocators - hence their outsized share price returns.

Disciplined and independent thinkers

These executives were capital surgeons, consistently directing available capital toward the most efficient, highest-returning projects. Over long periods of time, this discipline had an enormous impact on shareholder value… (204)

You have to be willing to always ask what the return is and to go forward only with projects that offer attractive returns using conservative assumptions. And you have to have the confidence to occasionally do things differently from your peers. (210)

You are right not because others agree with you, but because your facts and reasoning are sound. —Benjamin Graham (page 197)

Each of the eight CEOs followed a disciplined process to determine how to effectively allocate capital. This included objective decision rules that they strictly followed, such as the target return required to make an investment. Many ordinary CEOs fall down when they do not adhere to a disciplined investment process. For example, the outsider CEOs were very deliberate when they repurchased shares. When the price was right, they bought back an extraordinary amount of shares, otherwise they abstained. In contrast, many CEOs consistently buyback shares regardless of share price and often destroy company value in the process.

The outsider CEOs followed their own thinking and didn’t hire hoards of consultants and bankers to do the thinking for them. They knew their business the best and thus believed that they were in the best position to make decisions, not outside advisors.

Cash flow is king

In all cases, this led the outsider CEOs to focus on cash flow and to forgo the blind pursuit of the Wall Street holy grail of reported earnings. Most public company CEOs focus on maximizing quarterly reported net income, which is understandable since that is Wall Street’s preferred metric. Net income, however, is a bit of a blunt instrument and can be significantly distorted by differences in debt levels, taxes, capital expenditures, and past acquisition history. (Page 9)

the outsiders (who often had complicated balance sheets, active acquisition programs, and high debt levels) believed the key to long-term value creation was to optimize free cash flow, and this emphasis on cash informed all aspects of how they ran their companies—from the way they paid for acquisitions and managed their balance sheets to their accounting policies and compensation systems. (Page 10)

Cash flow is the driver of long term value, not reported earnings. The outsider CEOs understood this and ran their business with the explicit focus of maximizing free cash flow. This included running lean operations and using appropriate tax strategies.

Focus on key assumptions

Interestingly, he didn’t use spreadsheets, preferring instead projects where returns could be justified by simple math. As he once said, “Computers require an immense amount of detail…I’m a mathematician, not a programmer. I may be accurate, but I’m not precise.” (page 102)

The outsider CEOs believed that the value of financial projections was determined by the quality of the assumptions, not by the number of pages in the presentation, and many developed succinct, single-page analytical templates that focused employees on key variables. (page 200)

Many of the outsider CEOs had a technical background - engineers, mathematicians, etc - but they didn’t get lost in detailed financial modeling when they made decisions. They focused on the key assumptions and the impact of changing those assumptions on the attractiveness of the opportunity.

Conclusion

The good news is that you don’t need to be a marketing or technical genius or a charismatic visionary to be a highly effective CEO. You do, however, need to understand capital allocation and to think carefully about how to best deploy your company’s resources to create value for shareholders. You have to be willing to always ask what the return is and to go forward only with projects that offer attractive returns using conservative assumptions. And you have to have the confidence to occasionally do things differently from your peers. (page 210)

This book provides an insightful view into eight successful CEOs. The lessons drawn from these CEOs can be applied in many business contexts. I highly recommend this book.