In my opinion, culture is probably the single most important thing in business.
A good business model can be destroyed by bad management and poor cultural practices. The recent example of Wirecard is a case in point, but there are many others. Valeant Pharmaceutical’s strategy of significantly increasing drug prices worked, for a little while; but then massively backfired. If you exploit your customers in this way, I’m afraid it’s never going to end well.
A good culture on the other hand can become a huge competitive advantage, turning an ordinary business into a highly successful one. Howden Joinery, Next and Admiral, to name just three, operate in highly competitive industries but have been amongst the most successful companies in their sector for years. Economic textbooks will tell you their returns should have reverted to the mean decades ago. These texts of course don’t give culture a second thought.
Culture is hard to define, which I think is why many investors choose to ignore it or gloss over it (I think many professional investors are particularly guilty of this). It cannot be boiled down to a number on a spreadsheet. Anyone who’s worked in multiple businesses knows that some companies implicitly ‘get it’. They tend to make more good decisions than bad ones, and in doing so compound their advantage each year. Other companies always seem to make the wrong choices, despite often having good intentions.
For outside investors it can be a challenge to appraise the culture of a business. However, this doesn’t mean we should ignore it. Good investing is like being a detective or investigative journalist. You look for clues and try to build a picture that gets you closer to true understanding.
You will never get to ‘the answer’ and at times you will be surprised when the things you thought you knew turn out to be wrong or out-dated (remember, culture is always evolving). But in my view, investors ignore culture at their peril and should try as best they can to stack the cultural odds in their favour.
When I’m assessing the culture of a firm I consider two things – quantitative elements (including past financials, accounting and acquisitions) and more qualitative factors (like stakeholder relations). In this blog I focus on the former.
Attitudes to debt/leverage
We’ve seen a number of companies get into trouble during the COVID-19 crisis by running their finances in a way that left little room for anything to go wrong. We saw the same during the financial crisis. Some companies never seem to learn and always prioritise juicing short term returns at the expense of financial stability.
Use of leverage is, in my view, one of the best ways of assessing the inherent conservatism of a business. Personally, I prefer companies that conduct their affairs prudently. Business is risky enough and the world is a surprising place. I’m willing to give up the prospect of a few extra percentage points of return in exchange for knowing my companies can come through crises unscathed.