How 8 Successful CEOs Allocated Capital to Build Durable Businesses

Welcome to HBR on Strategy, case studies and conversations with the world's top business and management experts, hand-selected to help you unlock new ways of doing business. Think of the CEOs who made the strongest rates of return for investors and built the most durable businesses. What strategies do you associate with their success? Investor and author William Thorndike studied 8 CEOs who outperformed formed the market and their peers, including big names like Warren Buffett and Katherine Graham at the Washington Post, but also others who are virtually unknown, like Henry Singleton, an electrical engineer who ran Teledyne Technologies from 1960 to 1986. Thorndike noticed that these 8 iconoclastic leaders all took a similar approach to capital allocation. If you're not familiar with that term, it's what a company does with the money it makes. Of the 8 CEOs that Thorndike studied, all of them focused on investing their company's profits to repurchase their own stock at optimal prices. They also avoided large acquisitions, accruing debt, and paying dividends. In this episode, you'll learn how effective capital allocation strategies can generate wealth for shareholders. You'll also learn why many of these CEOs are still unknown today, despite their great success. This episode originally aired on HBR IdeaCast in April 2014. And just a note, we recorded this by phone. While the audio quality isn't great, the conversation is. I think you'll enjoy it.

Here it is. Welcome to the HBR IdeaCast. I'm Sarah Green from Harvard Business Review. Today, I'm talking with William Thorndike, the author of the book, The Outsiders: 8 Unconventional CEOs and Their Radically Rational Blueprint for Success. Will, thanks so much for talking with us today.

Thank you, Sarah.

So it's interesting to me that the book starts with a CEO you've actually— most people have probably never heard of, a guy named Henry Singleton. Why did you start with him? Who is he and why is he so important?

Yeah. Well, Henry Singleton was sort of the genesis for this whole project. So, um, I work in the private equity industry, and every other year we host a conference for our CEOs. And about 10 years ago, I raised my hand and said I would do one of the talks at that conference, and I decided to focus on Henry Singleton, who I'd heard a little bit about. Henry Singleton had a very unusual background for a CEO. He was an MIT-trained mathematician and engineer. He got a PhD in electrical engineering from MIT. While he was there, he programmed the first computer on the MIT campus. He proceeded to have a very successful career in science. He developed an inertial guidance system for Litton Industries that's still in use in commercial and military aircraft. He did a whole range of things. And then later in his career, in his mid-40s, he became the CEO of a '60s-era conglomerate called Teledyne. He ran that business for almost 30 years, 28 years. Over the course of that period of time, he generated extraordinary returns for his shareholders and substantially better returns than the other conglomerates of that era. So my talk focused on trying to understand what the sources of that outperformance were. He sort of— Henry Singleton sort of created a template that it turned out the other CEOs in the book followed, and specifically around a series of actions he took in the area of capital allocation.

So it's interesting because when you're talking about sort of iconoclastic CEOs, the idea of there being a template is a little bit surprising. When you're talking about such unconventional people, were you surprised that there were certain things they had in common?

Yeah, that was the greatest surprise in doing the book. So basically, I did the book sort of one chapter a year, working with second-year students at the Harvard Business School who helped me with the research and some of the analytical work. And my expectation as the project went along after that first year after Henry Singleton was that it might over time be sort of a group biography sort of a format similar to, you know, Profiles in Courage or a book called The American Political Tradition. But after about the 5th chapter, 5th CEO, it became clear that there was a much stronger than anticipated pattern across the group that, you know, each of the CEOs had to meet 2 tests. Each had to have better relative performance compared to the market than Jack Welch had during his tenure. And then each had to meaningfully outperform their peer group. And in order to do that, sort of by definition, they needed to do things differently than their peers, but it turned out that the actions they took were remarkably similar across the group. So that was the most surprising finding, was the strength of that pattern.

So, well, to back up just for a moment, why index against Jack Welch?

Well, he, I think, is sort of a de facto gold standard for CEO excellence. I mean, his returns are very, very good. You know, he ran GE for 20 years and over that period of time generated a 20% compound return for GE shareholders, which is pretty extraordinary. And he's just an extremely well-known, constantly in the public eye figure. So I think he's sort of a de facto gold standard for CEO excellence. So that's the reason for including him.

Okay. And now what were some of those actions that these different iconoclastic CEOs had in common?

Yeah. So basically capital allocation The framework I think that's most useful to think about that is that CEOs need to do two things well to be successful in the long term. They need to optimize the profits of the business that they're running. They need to run the operations efficiently. That's obviously critical. But secondly, and equally important, they need to deploy or invest those profits over time. And that second activity is called capital allocation. And it, over long periods of time, it has an enormous impact on shareholder returns. So if two companies have identical operating results, but different approaches to capital allocation over long periods of time, so the average tenure of the CEOs in this book was, you know, north of 20 years, they'll drive very, very different returns for shareholders. And so the framework there is there's three basic ways a company can raise capital. They can, you know, tap their existing profitability, their existing profits. They can raise equity or they can sell debt. And there are only 5 things they can do with it. They can invest in their existing operations. They can make acquisitions. They can pay a dividend. They can pay down debt. And they can repurchase stock. That's it. Those are all the choices. And over long periods of time, those decisions have a significant impact for shareholders. Okay, so getting back to your question, what this group did is they were very substantial repurchasers of their own stock, very opportunistically. All of them bought in, with one exception, bought in at least 30% of their shares outstanding. They made occasional, very large acquisitions. They were selective users of debt, and they generally avoided dividends.

And why do you think that that pattern was so effective?

Well, it translates into— I guess I would describe it as a patient and opportunistic approach to investing the firm's profits. And so over long periods of time, doing those things I just described and effectively buying things when they are low, so repurchasing your stock when its multiple is inexpensive or purchasing other companies at attractive prices, And similarly, you know, being in a position to sell when prices are higher, so to either sell stock or to sell businesses over long periods of time, that has a very, very significant impact on shareholder returns. And there are, you know, some interesting examples in the book of CEOs who did that very well, the outsider CEOs, and then peers who did it less well.

Well, I guess I'm interested in perhaps knowing why, for some of our listeners who may not have a sort of investing background, why would something like buying back your own stock be ultimately useful for a company?

Yeah, that's a good question. And I would say if you look at the general pattern of stock repurchases today, that pattern I think is unlikely to produce compelling long-term returns. So in the typical case today, a company that's pursuing repurchases will get an authorization from its board for a certain amount of capital that it can then use to repurchase stock, and it will then proceed to purchase stock kind of in even amounts over a quarterly period of time or maybe, you know, semiannual period of time over some sort of a regular schedule. And that pattern is very different than the pattern the outsiders used in repurchasing stock. Their pattern was to wait very long periods of time with no repurchase activity, And then when the stock was priced at a very low P/E multiple, at an attractive price, they would buy in significant amounts of stock. So it was a very different— and so the reason that's good for shareholders, the remaining shareholders, is you're basically retiring shares of the company at prices below what it would be worth in a control sale. So for the remaining shareholders, you end up owning more of that existing business and its future profitability than you would otherwise.

So it's a model that's really very focused on the company as a vehicle to create wealth for shareholders. Is that correct?

Yes, that's correct.

You know, Will, one of the things I noticed in the book is that you really call on a diverse array of different kinds of outsider CEOs, as you call them, all the way from someone like Warren Buffett, you know, very well known, to someone like Katherine Graham of the Washington Post, who has often been overlooked. And they come from an enormous diversity of backgrounds and in an enormous diversity of industries. So if someone out there is hoping to follow the model that you discuss in the book, how likely is it that that person will actually be able to apply the model that you lay out here?

That's a good question. Yeah, I think the model is very robust. I mean, if you look at the, industries represented in the book. The companies that these CEOs ran competed in industries ranging from insurance to manufacturing to media to defense and consumer products. So a very wide variety of industries and a variety of stages of development. Some of them were CEOs who were involved from the very early stages in building companies. Others came in later into very mature businesses and were sort of stewards. It's interesting, as you mentioned, Buffett is without question the best-known CEO in the book and his record sort of speaks for itself. But the variety of backgrounds I think is very interesting. There were some commonalities across the group in terms of background. All of them were first-time CEOs. Half of them under 40 when they took the CEO seat. Only 2 of them had MBAs. One was an astronaut in his life before entering business. Katherine Graham was a widow. Warren Buffett was a professional investor who'd never run a company before. They shared an interesting set of personal characteristics in addition to some of the specific business actions they took. So they were, as a group, sort of humble and frugal by nature and sort of patient and pragmatic in terms of their mindset. They were not overly charismatic and they were not active seekers of the limelight. They did not speak at Davos. Buffett is far and away the best known. Many of the other CEOs are virtually unknown today. Singleton would be an example of that. He's just not well known except among a handful of sophisticated investors who were involved investing at the time he was running Teledyne.

Well, Will, thank you for taking some time today to shed some light on some of these really interesting CEO careers with us today.

Thanks very much, Sarah.

That was investor and author William Thorndike in conversation with Sarah Green on the HBR IdeaCast. Thorndike's book is The Outsiders: 8 Unconventional CEOs and Their Radically Rational Blueprint for Success. We'll be back next Wednesday with another handpicked conversation about business strategy from the Harvard Business Review. If you found this episode helpful, share it with your friends and colleagues. And follow our show on Apple Podcasts, Spotify, or wherever you get your podcasts. While you're there, be sure to leave us a review. We're a production of the Harvard Business Review. If you want more podcasts, articles, case studies, books, and videos like this, find it all at hbr.org. This episode was produced by Anne Sanny and me, Hannah Bates. Ian Fox is our editor. Special thanks to Maureen Hoak, Audie Ignatius, Karen Player, Ramsey Cabaz, Nicole Smith, Anne Bartholomew, and you, our listener. See you next week.