The stockmarket X factor

The information in this article is market commentary only and reflects Lincoln's views and beliefs at the time of preparation, which are subject to change without notice. To obtain up-to-date information, please contact us.

Investors looking for growth are trying to find businesses that will be bigger tomorrow than they are today, lifting profits and revenues as they deliver new and innovative products to market, expand into new jurisdictions or make strategic acquisitions.

Those of us that have invested in the market for the long term know that every chief executive will err on the side of grandeur when it comes to selling the company’s growth prospects. The sad reality is that not all fairy tales in the sharemarket have happy endings. Therefore, spending time validating and justifying what we are being told is a big part of an analyst’s role.

Even if what we are being told is achievable and makes sense, it doesn’t guarantee success. Some of the best companies and/or products ever invented failed to meet their full potential. So why do some succeed and others fail?

Sometimes it can be timing and luck. But more often than not, each successful growth story will have an “X factor” that drives the business to success.

Three such X factor elements that we monitor closely involve the stories behind the businesses, whether the founders are still involved and are driving the company forward. Understanding these elements will give you a sense of the reasons for a company’s success to date and the likelihood of the success being sustainable.

The company story

We like to understand the history of a business to get a sense of its roots, its past successes and, just as important, its failures. This allows us to establish an understanding of the motivation behind the company. The founding date should not be confused with a company’s listing date. A company may list many years after it was founded. Companies with deep roots in an industry will often have an added advantage of experience and past learning to help them along the way. Those without this deep insight may be prone to making judgment calls and relying on potentially poor strategic advice from corporate advisers.

Founder involvement

Our view is that having a key part of the company’s DNA on board to drive the vision, set the expectations and share their experiences can be a key a element to future success. A number of MBA academic studies, particularly in the US, have explored the benefit of having founders who continue to be involved in a business. Founders are likely to drive a company’s purpose, have an obsession for delivering quality outcomes and will take responsibility for success or failure.

Skin in the game

We love it when the people involved in the business are heavily invested in the outcomes. This goes a long way to ensuring that their interests are aligned with those of shareholders. It is also not just important they have skin in the game, but that they demonstrate a long-term commitment by not selling down their holdings. While some may justify the sell-down as a means of diversification, what better investment would anyone want to make than one that they are directly responsible for? Sometimes selling down a significant interest may be a sign that business growth is on the wane. This is not a message you want from a business leader. And, given some recent high-profile examples, it is definitely “buyer beware” when it comes to buying the boss’s stock.

While these X factors rarely make their way into the analyst research reports and by no means guarantee success, applying a bit of street smarts to your investing decisions can be a big help. There is mounting evidence to suggest that companies that have a strong heritage and are driven by founders with skin in the game outperform over the long run and can be strong contributors to a business’s long-term success. A success that, as investors, we can all share in.


Published Tuesday 6 June 2017 | The Australian Financial Review

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