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The Link Between Great Management and Bottom-line Profits
Louis Rukeyser has said that evaluating a corporate management in isolation of the company it leads is every bit as difficult as evaluating the director of a Broadway play. He's right. We tend to evaluate managements and directors backward; if they produced a hit, they must have been pretty good, and if they didn't, well, you can draw your own conclusions. But a backward conclusion isn't worth much in the stock market, because you can't invest inthe past.
Yes, investors should demand strong management from companies whose stock they own. But how can you tell? Wasn't Enron once the most admired company in America? Certainly an investor's job is made easier when a company has a visible leader at the helm whom investors can get to know and trust. If Warren Buffett weren't leading Berkshire Hathaway, you can bet that the annual meeting would be considerably less crowded-and that his company's approach to business would be less widely understood.
In the absence of a charismatic personality to deliver the corporate message, you as an investor must do some legwork. You can begin by reading the annual report to see the human faces behind corporate performance. When you read on, you hope to find more than glossy pictures. You're looking for a clear link between the actions and philosophy of management and the bottom-line profitability of the company. Above all, the question you should be
asking is "Has this company distinguished itself from its competitors?" If the answer is no, then management hasn't made its case.
In this chapter we see that three outstandingcompanies-AIG, GE, and IBM-were more than just a sea of initials; they were great long-term stock selections. Investing for the long haul requires unusual confidence, and those investors who truly understood the management teams behind the scenes were the most confident of all.
American International Group
AIG was that actuarial's complaint-the statistical anomaly. It was a big insurance company that was still growing at a gallop, making money in good times and bad. Not many insurance companies could say the same over the last quarter of the twentieth century, which is what made AIG so cool and consistent. In other words, it was an investor's dream.
When analyzing the quality of a company's management, it's natural to start at the top. Not every CEO gets to be a national media star, so it can take a bit of legwork to learn how a company is run. The process is certainly easier when there's continuity in the executive suite.
Investors who prize continuity hit the jackpot with American International Group. What has set it apart over the years has been management's insistence that growth take place away from the commodity segment of the business. Every single CEO of AIG felt the same way: both of them, that is.
Two Strong Leaders = One Great Company
From 1919 to the present day American International Group (AIG) has had only two CEOs, Cornelius Starr and Maurice Greenberg, and it's been the better company for it. The latter is bombastic and the former was reticent, but outward personalities aside, their philosophies have reflected the same values, and given AIG a distinct corporate culture. Most of all, the romance of the insurance giant, incongruous as that phrase may be, is a deep involvement in business all over the world. Since the day AIG opened its first two-room office in Shanghai in 1919, overseas revenues have been central to the business, and accounted for about 50 percent of operating income from 1988 to 2000. The company stock was not only an insurance play, but for an individual portfolio, it also offered one-step global diversification.
Both Starr and Greenberg were alike in believing that every center in the business is a profit center, or should be. One arm could not be expected to make up for another. Greenberg in particular has long believed that innovation is essential to AIG's growth. The company, therefore, cast a wide net, including the more mundane property-and-casualty, marine, life, and auto insurance, of course, but it also would offer the more exotic, such as insuring children in day care against kidnapping and Internet websites from hackers. With so many types of policies and different entities to sell them, "innovation" has translated into a corporate structure so complicated that AIG could be called a corporate spiderweb, woven of as many as 300 subsidiaries.
To say that Greenberg wanted AIG to grow would be an understatement; by his own confession, he has thought nothing else ever since he took over in 1968. One year into his tenure, he oversaw AIG's first public offering of shares. The stock thrived on Greenberg's dictum for the company-earnings growth of nearly 20 percent per year. It was easier to say than to do, but from 1968 to 1998 AIG found ways, ridding the books of lagging businesses and starting or acquiring ones with glowing potential. By the mid-1980s, the company easily hit Greenberg's target, as assets grew by an average of 34 percent from 1984 to 1988, while in each of the four preceding years growth in earnings followed at an average clip of 27 percent. During that time, the stock price languished, due to the pessimistic perception of the whole property/casualty sector. Smart investors may have been accumulating AIG stock, but the price didn't really start to move until 1988. That year, with Asian markets booming, Wall Street looked for companies poised to benefit. AIG was belle of the ball.
Americans were hearing a great deal about the accelerating overseas economies of the Pacific Rim and AIG offered a ride along with those "tiger" economies. The stock, which had made precious little progress between 1985 and 1988, burst out, showing that insurance could still be a high-growth industry when it encompassed practically the whole world.
From 1988 to 2000, AIG stock increased from a price (adjusted for splits) of $4.85 to $110. A $10,000 investment would have been worth $226,804 after a dozen years. Even more intriguing for investors, AIG was surefooted. The stock moved upward without a noticeable downturn or even a plateau. In that sense, it only reflected the company, which turned a profit even in years when the earnings reports of other property-and-casualty companies were laid waste by hurricanes or other natural disasters. While AIG stock easily outstripped the S&P 500 (average of large companies), as well as its own brethren in the insurance sector, it also stayed ahead of the NASDAQ average. AIG was one of the anomalies of the 1990s bull market, which was largely propelled by nascent high-tech companies: it was old company, old economy, but decidedly high-growth nonetheless.
One of the things that helps distinguish AIG is its origins. In 1919, fresh from service in World War I, twenty-seven-year-old Berkeley grad and lawyer Neil Starr went to Shanghai looking for opportunity. He found it, all right, in a nation of millions unable to buy their own life insurance.
The Chinese people were going uninsured because the British companies that dominated the business in China wouldn't consider selling life insurance policies to native Chinese. The only logical reason for the English position was that actuarial tables (which predict average life spans) did not yet exist for the Chinese population. These tables are key, because normally the people who issue policies depend on tables in order to set rates. So, Starr saw quite a business. He founded American Asiatic Underwriters (AIG's predecessor) and established a pattern when he extended his company to include life insurance for Chinese nationals, estimating longevity and setting rates that ensured a profit.
Another hallmark of Starr's young company was that its staff was exclusively Chinese. Foreign companies in China nearly always employed their own imported managers and salesmen. Starr hired locals. As his company expanded into other Asian nations and into other types of coverage, he continued the practice of relying on native-born employees. In the late 1920s, Starr, by then married to the daughter of a Canadian missionary, returned to the United States to build up the center of his empire. He purchased several of the insurance companies that his agency represented and started new firms, too, most of them with an overseas connection. During World War II, he was especially aggressive in South American markets previously dominated by German and Italian firms. Privately held, the burgeoning insurance conglomerate made a millionaire of Neil Starr, but he began to neglect it somewhat in the late 1950s, when he had a personal crisis. (He was devastated when his wife left him for a Russian painter.)
Neil Starr's companies, which would assume the name American International Group in 1967, were global long before most other American financial firms started to look overseas. The difference was patience, as Starr and his colleagues learned the intricate art of insurance on a mosaic of more than a hundred countries. They took the time to understand local customs and to navigate regulations that baffled many U.S. firms. One of the toughest challenges was retaining sharp employees in developing economies, where AIG training often made a worker worth more than even AIG could afford to pay.
The Next Generation
Even though AIG had thousands of policies, offered by hundreds of subsidiaries, the man Neil Starr tapped to replace him believed that the behemoth was basically quite simple. Maurice Greenberg, nicknamed "Hank" after the Detroit Tigers ballplayer of that name, grew up on a farm in upstate New York. He earned a law degree between stints in the army during World War II (in which he landed with the Rangers during the D-Day invasion) and the Korean Conflict. After distinguishing himself in a domestic insurance subsidiary, he was picked as president of AIG. "Sometimes I find a man who has an inner fire, a man who is perfectly in his métier, his orbit," Starr once said of his ability to choose executives, "and when I do, I back him."
Hank Greenberg's zeal for new businesses led AIG to pioneer coverage in many new areas. It insured satellites, offshore oil rigs, and computer networks; it protected companies against the cost of environmental cleanup and corporate directors from shareholder lawsuits. A subsidiary called AIG Political Risk wrote insurance against kidnapping and extortion. With the help of consultants such as Henry Kissinger, AIG continued another tradition, pushing across forbidding political boundaries.
AIG sought permission in 1992 to stage a homecoming and reestablish operations in mainland China, from which foreign businesses had been barred when the Communists took power in 1949. Hank Greenberg stepped up as the lead salesman and worked the prospect tirelessly. Meanwhile, his company quietly cultivated favor by investing heavily in a Shanghai office complex. AIG also took the initiative to locate a set of windows stolen long before from the Summer Palace in Beijing, buying them for $500,000 from a European collector and restoring them to the palace as a gift to the Chinese people.
"It took almost a decade and a half to open China for AIG," Greenberg wrote. "It took dozens of trips. Most CEOs I know who want to open a foreign company want to meet with the leader of that country once. After that, they believe they've done all that's required. It doesn't work that way."
Net income, which was $17.2 million when Greenberg took over in 1968, grew to $50 million in 1975. By 2000, it was $5.64 billion.
INVEST IN SKIING?
Anyone looking over the long list of assets of American International Group (AIG) might wonder why one of the world's most potent insurance companies owned a ski resort in Vermont. However, this was no investment fad: AIG had owned Mount Mansfield in Stowe for more than forty years. The reason was twofold: first, Cornelius Starr liked to ski. Second, Maurice Greenberg liked to ski.