The purpose of this weekly is to sharpen my thinking by sharing thoughts about industries and companies that fit into powerful long-term investment themes. It is also a place to share insights into decision-making, takeaways from the past week, and random thoughts that arise. Thank you for reading this piece! Feedback is welcomed. 

This week: 

Looking for mastery: Business Model Analysis 

Traffic Behavior <> Management Behavior? 

Traffic Behavior <> Investor Behavior 

Looking For Mastery in the Business Model 

One thing we believe we use in our analysis of companies much more than other investors is human behavior on the part of management. 

Over my long career, I have learned the hard way that management teams that exhibit results that shout, “We know what we are doing!” means that for the most part, they do know what they are doing. 

As a result, we spend much of our quantitative analysis early in the process. We have a worldview and philosophy of only owning companies with proven business models, where you can point to mastery in their efforts. That, we believe, translates into a portfolio full of amazing companies regardless of size and geography. 

I have come to appreciate that the best management teams and leaders have a different gear regarding business sense and discipline. 

I spent much of my formative years in the investment business, feverishly learning as much as I could about a company. I would learn about the details of each product and model out projections. While there certainly is a lot of value in knowing about the company and its products, I have found my ability to predict how good one product is versus another is decent, not special. I have learned that

my predictions are not all that great, but I believe that I am in good company. So, I now look for mastery in the consistency of their results. 

I have come to appreciate that when you see a company exhibit consistent growth and an ability to produce margin, cash flow, and high returns on capital, that’s a significant advantage for both the company and its investors. Identifying a well-run business increases our odds of a successful investment. 

This can be a bit disconcerting at first but highly liberating over time. What I mean is that it is natural to have thoughts that since the future is uncertain that past success is not a precursor for future success. It also turns over some (or a lot) of the control… What I have come to understand better is that seeing a great model doesn’t come around often, and it deserves a lot of attention. 

What Behavior in Traffic Can Tell Us 

I made a connection recently that I have used to describe the type of management we look for sorted by the types of drivers in traffic. I’m talking about the type of traffic where cars are traveling at less than 10mph. 

Some drivers consistently stay in the same lane. Some drivers weave in and out of lanes as they see a different lane moving quicker than theirs. What does this have to do with a company?? 

We prefer to put our money with the type of driver that stays in their lane, seeing the reality that their lane is just fine and that is not worth the risk of changing lanes constantly for, at best, a marginal gain. 

There have been some studies that indicate that weaving in traffic can net gains of a few minutes (2-3 minutes) in an hour’s commute. But a significant number of car accidents happen in traffic. In our minds, why endure the risk of a crash and added stress for marginal gain? 

If a company already has a strategy that produces results already and clearly knows what they are doing, why would it change lanes? 

Companies that seem to undertake new initiatives often and appear to be in a state of chaos are probably in a state of chaos. The new initiative(s) may work out, but to investors like us that think probabilistically, this is not attractive. They appear to

be switching lanes in the hopes that the lane they chose will get them where they want to go quicker. 

Does that mean we don’t want companies that invest and take risks? No, quite the opposite. We want companies that will reinvest, but we favor those that have posted high rates of return to increase our odds of success. In fact, investments in the form of new initiatives and tuck-in acquisitions can very much be a part of staying in the lane. 

Weaving behavior to us is making a “transformative” acquisition to immediately gain scale, especially in an area that is different from their core competency. We would suspect this may be driven by a desire to be a larger company without the patience to wait for the existing model to scale naturally. 

When we reflect on the best business builders over the last 30 years, they appear confident in their approach, and the results said as much. When you look back after 5 and 10 years, they tend to deliver what appear to be the same types of numerical results even though circumstances such as the economy, interest rates, innovation, and other factors are all different. 

One way to further describe this is through the difference between urgency and stress. We want managers that have a good thing going and exhibit urgency. We stay away from weavers that seem to exhibit stress as a business plan. 

Traffic Behavior: Investment Takeaways 

The analogy of staying in a lane versus constantly changing lanes can apply to investing as well. If a manager is fundamentally based and has a philosophy of owning quality companies, it stands to reason that they would mostly stay in their lane. There are two competing forces, however, so it may be good to use this analogy to consider when making decisions as an allocator, investor, etc. 

The first competing force is the notion that we need to constantly be doing something to add value. It is around us at every turn. Success stories in short time frames posted on social media. Stories about people working crazy hours and how it leads to success. The point is that there is an association in society that doing more is good. If a manager owns one quality company and swaps it for another quality company, what are the odds that the new company will be a better choice?

The second competing force is the illusion of control. Again, what makes the new choice better than the old choice? If a manager is following their process, the changes made should add value over a longer timeframe. Some changes are good in any process, the world is constantly changing. Constant changes incur transaction costs and are subject to timing, both of which carry risk and costs. Our view is that company outcomes are probabilistic, with the variables that affect the outcomes changing constantly. We believe that while we may believe that we are in control, we really are not in control of the outcomes. We admire the companies that create value by being confident in their strategy and staying in their lane. We aspire to execute on this very premise by staying in our own lane. 

My story 

I am an investor and entrepreneur, having started two investment companies. I am the Founder and CIO of ArrowSide Capital (http://www.arrowside.com), based in Boston, MA. I have more than 30 years of experience in the investment business, investing in companies geared toward innovation and growth. The blog is named 

The Zen Innovation Investor because I believe it is so important to remain calm and focused during the rapid pace of change in the world today. I am keeping a view of the long term while also keeping abreast of developments in the world of innovative companies. I view this as a place to sharpen my thinking and provide some insights that are thought-provoking. 

Disclosures 

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