The Surprising Advantages of Investing in Family Businesses
Investor goals align with the owner goals
Hi Everyone,
Before digging deeper, I prefer to conduct a basic screening when searching for stocks to add to my portfolio. Before wasting my time searching for the greatest bargain or the best stock, I like to look for the low-hanging fruit, the clear signals that indicate this stock deserves my attention. You can find some of the obvious signs I look out for in the following article:
And, as I've mentioned in previous writings, my fundamental investment philosophy is to win through downside protection. If I am protected against large losses as good as possible, the upside will take care of itself over time. Therefore, I seek out companies that are already designed so that there is little space for error, or if errors do arise, they have a minimal impact on the business, allowing me to sell my stocks in a timely manner if things go south. This leads me to the topic of this article: Family-owned businesses (This includes single founders too).
First and foremost, we must remember that many investment mistakes are psychological. People lack a long-term perspective, take uncalculated rather than calculated risks, fail to conduct thorough due diligence, follow the herd, etc.
But what if I told you that you could "outsource" these issues so that you never have to deal with them? So that you do not even run the chance of making such errors, you need someone who is financially motivated to manage your money correctly.
Remember that every management decision appears on a per-share basis sooner or later, and with each dollar you invest, you seek the best value. A team that is highly motivated to handle your investment in the most profitable manner is the logical response to such challenges. And what could be better than owners who have a stake in the company and are in the same boat as you?
Let’s take a look at some benefits of family-owned businesses
Family businesses place a greater emphasis on resilience over performance. They prioritize ensuring the long-term viability of the business, even if it means sacrificing potential gains during favorable economic conditions. The decision-making process for a CEO in a family-controlled firm is shaped by both financial incentives and a sense of familial duty, leading to distinct strategic choices. These executives often adopt a long-term perspective, focusing on building a strong foundation for future generations. Additionally, they prioritize risk management and stability over generating exceptional returns, which is a departure from the typical approach of non-family CEOs. And over time, this approach pays off.
They carry less debt than the average company. In corporate finance, the appropriate use of debt is considered a positive aspect as it maximizes value creation through financial leverage. However, family-controlled firms have a different perspective, perceiving debt as a source of fragility and risk. This viewpoint stems from the belief that excessive debt limits the ability to respond effectively to unforeseen events or setbacks. It’s in the family’s interest to not give away too much power to the banks.
They manage their own money. In instances where a controlling group holds a significant portion of their net worth in a particular investment, careful planning and scrutiny are typically exercised. This group, being aware of the significance of their investment to their family's wealth, is unlikely to engage in high-risk strategies or careless spending habits. Most people are more frugal with their own money than someone else’s. The economist Michael Friedman set up a spending matrix that illustrates this problem in his book Free to Choose:
A long-term owner develops a lot of knowledge about their industry. A company with high management turnover often lacks the stability and wisdom needed for long-term success. A new chief executive officer may feel the urge to break out on their own and make their mark, but family-led enterprises are more likely to have long memories of what has and has not worked, as well as the fragility of the economic cycle. It’s plain and straightforward: Knowledge compounds over time, and so does shareholder value. Just take a look at some stocks that have the longest-serving CEOs in the S&P 500 SPY 0.00%↑ (data is from 2021):
Most of them are not only CEOs for decades but also founders. Who knows their industry better than those guys? The stock price development of the mentioned companies speaks for itself.
When a founder or family spends all their life building a business, a long-term orientation tends to cover all areas of the business: customer relationships, product lines, investments, R&D, CAPEX, customer service, employees, and salaries/compensations.
“Successful CEOs think more like investors than managers.”
Final Thoughts
The attentive reader will have noticed that the above-mentioned advantages of family or owner-managed companies are in line with well-known successful investment strategies. What you should do yourself as an investor (no speculation, long-term view, invest for downside protection) is additionally complemented by the company.
Family-run companies thus offer investors who cannot adhere to proven strategies themselves the possibility of implementing a disciplined investment strategy that bears fruit over the years. This brings us to the intro of this article: the low-hanging fruit. I always prefer to let the management do the main work. My task is then simply to select the right management and wait.
Who can navigate a difficult economic cycle better? Me, through trading in and out and trying to time the market? Or an experienced team that has accumulated decades of knowledge? Therefore, I usually check the ownership structure of a company, not only to find out if it’s family-owned but also to get new investment ideas. Maybe a quality business is held by an asset manager that I’m unaware of? Maybe this asset manager holds other quality stocks that I could further research, and so on…
I hope you learned something today, until the next issue. 👋
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