Chapter 10. Sitting and Watching


You only find out who is swimming naked when the tide goes out.

 --—WARREN BUFFETT, in his 2001 annual letter to shareholders

We look for certain behavior patterns in management that are consistent with an efficient and prudent guardianship of our assets. If we visit a fan manufacturer in Texas and the CEO meets us at the airport in his Lexus, spends five hours with us, and then takes us out to an expensive restaurant and buys $300 bottles of wine, that is suggestive of somebody who isn't as prudent as we would like.

 --—J. CARLO CANNELL, portfolio manager, 2006 interview in Value Investor Insight

The heart of capitalism lies in finding an unmet need, providing a solution, and then keeping ahead of competitive offerings that may be cheaper, better, or faster. Staying on top requires constant vigilance and continued good judgment.

From the outside, it can be difficult to tell whether management is making good choices. Decisions made today affect the profits of tomorrow. Should this research project be funded to completion or killed? Should we introduce this new product? A few big decisions and a thousand small ones determine a company's future.

Investors may not be able to vet every management choice, but they can watch for clues to how a company's management makes decisions and treats shareholder capital. If the visible decisions appear to be wise, the logic goes, it's likely that other, less visible decisions are also carefully considered.

An example ...

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