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Don't "Tin Cup" It

Jeff Miller

Roy (“Tin Cup”) McAvoy: “If I had it to do all over again, I'd still hit that shot.” Romeo: “Man, you'd bury yourself alive just to prove you could handle the shovel.”

Tin Cup, 1996

Eventually, many investors face their own “Tin Cup” moments, when they think they are smarter than the market or the management team running a business. Some—the activist investors that make the news—may be so blinded by their egos that they believe they can turn around a poor-performing business, if only they owned a large stake, threw out the current management and ran it themselves. With few exceptions, we think scenarios like this are recipes for disasters. In Tin Cup moments, investors ignore what made them good in the first place, which was hitting the ball down the middle of the fairway and then chipping onto the green for a par. Boring? Maybe. Effective? Absolutely.

As value investors, one of our trading rules is “don’t Tin Cup it”—that is, don’t try to reach the green with a subpar company. Most companies that are bad are bad for a reason: they have toxic cultures, bad management, second-tier products, etc. Turnarounds and comebacks make for great storylines in the movies, but in the real world, these stories usually are just that—stories. Weak companies tend to stay weak, and strong companies tend to stay strong. For years, this truth has been the basis of our team’s value investment process: find strong companies first, then buy them when they are cheap.

So how do we do this? “Cheap” is straightforward. “Strong” is where the work comes in. For us, a strong company is one that earns a high return on invested capital and can sustain that high return over time. The trick is finding the companies that “can sustain that high return over time,” which is why we spend a lot of time researching companies and visiting with management teams.

While most people can tell you what makes a strong company, far fewer can identify them. Think about companies like people: All of us know how to look as fit as Brad Pitt; it’s actually quite simple so long as your genetics aren’t totally against you. Workout hard and regularly while eating a high-protein, low-carb diet. Do this religiously for three to six months and voilà—Brad Pitt in chinos. But then why don’t more people look like Brad Pitt? Lack of discipline, time, energy, desire.

It is no different in Corporate America. Many times we hear investors say, “If XYZ company just acts more like ZYX company, it can earn a 15% return on equity and trade at 15x earnings.” Well, yeah. But the fact is that XYZ company is unlikely to act like ZYX, absent a serious cultural and management change.

Some companies are just miserable places to work, which drives away their human talent. Some lack leadership, so management drifts from strategy to strategy, always with a new story to tell but never really making any money. Others are stuck making a second-rate product that is in decline. Without a major business shift, these businesses are destined to earn mediocre returns and trade at commensurately mediocre multiples. There’s not a lot of money to be made in these types of companies.

Tin Cup McAvoy: Suppose there's this guy, and he's standing on the shore of a big wide river, and the river's full of all manner of disaster, you know, piranhas, alligators, eddies, currents, stuff like that. Nobody'll even go down there to dip a toe. And on the other side of the river's a million bucks, and on this side of the river is a rowboat … I guess my question’s this: What would possess the guy standing on the shore to swim for it?

Dr. Molly Griswold: He is an idiot.

Ah, that brings us back to those activist investors who are in the news all the time, taking on poor management teams and restructuring businesses. To paraphrase Warren Buffett, when a good manager meets a bad business, usually the business wins. We’ll stick with the strong businesses, thanks.

The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.

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