The Danger of Never Falling in Love

Don’t get close to management. Don’t like the company. Don’t become attached. Because eventually your judgement will be compromised and you’ll get hurt. 

This is often how investors are taught to think about management teams.

When I first started investing, I encountered this common trope repeatedly. If you speak to management, meet the CEO face to face, or get to know the people running a company personally, you will inevitably become biased and lose your ability to make rational investment decisions. Some well-known investors have gone so far as to caution against speaking with management at all. 

After nearly 15 years on the buyside, I have come to believe almost the exact opposite. Particularly in the part of the market where I spend the most time, I think it’s unbelievably important to get to know the people allocating your capital.

The value is in gaining another source of information. Access lets you evaluate judgment, incentives, temperament and decision-making in a way the financial statements cannot. None of that requires surrendering skepticism and you certainly don’t have to become their friend, accept their projections, or substitute their charisma for good execution.  

Financial statements help paint the picture of what a management team did. Getting to know them helps you understand how and why they did it. The best relationships I’ve had with management teams help me understand, over time, how they think about customers, competitors, employees, capital allocation, mistakes, risks and opportunities. I get to see whether their explanations remain consistent when circumstances change. I learn whether they understand the economics of their own business at a granular level or merely know how to communicate the story. I love seeing management respond to a difficult question, admit when they are wrong (or not), and get a sense of whether they can distinguish what they know from what they merely believe, and whether the priorities they discuss privately resemble the priorities reflected in the financial statements.

Businesses and organizations are collections of people making thousands of decisions over long periods of time, often with incomplete information. If you think long-term, the further out your investment horizon extends, the less useful any individual earnings estimate becomes and the more important the quality of those decisions becomes. If my aim is to own a company for five or ten years, I want to know as much as possible about the people who will be making decisions with my capital during that time frame. 

There is also information in the passage of time. One management meeting tells you very little, but multiple conversations per year over several years can tell you a lot. I like to  compare what management said in a meeting years ago with what actually happened and observe how they behave when things aren’t going well. What happens to communication, transparency, and execution when an acquisition goes poorly, or margins disappoint, or shareholders point out a mistake? How about when the stock is down -50%? Character, judgment and temperament are much easier to assess when circumstances aren’t favorable. 

The end result of this, is that sometimes you end up liking these people. 

I would argue this is not inherently a problem. In fact, you should want to like the people running your companies. Why would I voluntarily allocate capital to someone who I don’t believe is intelligent, talented, hardworking, communicative and trustworthy? I wouldn’t view those characteristics as sentimental considerations separate from investment analysis. In many cases, they’re key variables in the analysis itself.

The obvious risk here is that familiarity turns into affection, that affection turns into attachment, and that attachment eventually overrides disconfirming evidence, which I’m sure happens. But the appropriate response to a potential bias is to acknowledge it and build a process around it, rather than discard a valuable source of information altogether.

I’ve made plenty of investment mistakes in my career, but I have never failed to sell a stock I believed needed to be sold simply because I liked the CEO. If anything, knowing management well has often made changes easier to identify. When you understand someone's normal way of thinking, communicating and behaving, deviations become more obvious, not less.

One way I try to make this more systematic is by thinking about management risk in a few different buckets: 

• Operating risk: Who is actually making the day-to-day decisions, and how dependent is the business on that individual?
• Cultural risk: What does the CEO or management team embody that is crucial to the organization? Are they uniquely responsible for maintaining that culture, urgency or set of values?
• Capital markets risk: Do investors trust them? Can they communicate the business clearly and credibly, particularly when things aren’t going well?
• Strategic judgment and capital allocation: What toolkit do they bring to the job, and what does their history tell you about the quality of their judgment?

It’s difficult for me to understand how an investor could properly assess any of these things while deliberately avoiding the people involved. Or, to invert the question, how could doing more work to understand these risks somehow make the analysis less rigorous? 

I think this gets to the heart of an important lesson. 

There are two opposite ways to make the same mistake. Investment culture constantly talks about the first: falling in love with a company or management team, becoming emotionally attached, and rationalizing deteriorating evidence or a broken thesis. That happens, and investors should guard against it. 

Far less attention is paid to the opposite error of becoming so afraid of attachment that you refuse to recognize when you may actually own something exceptional.

That can be enormously expensive for a long-term investor. If every time a company becomes more entrenched, more loved by customers, better run, and earnings power increases, you tell yourself, ‘don’t fall in love, don’t get attached, take the gain’, you systematically prevent yourself from owning the handful of businesses capable of producing extraordinary long-term outcomes.

The discipline, then, is to allow conviction to deepen as the evidence improves, while continuing to demand new evidence.

Most of us are taught that it is some kind of mortal sin to like a company we own or the people running it, for fear that doing so will eliminate our ability to respond rationally when the facts change. God forbid we actually enjoy owning one of the businesses in our portfolio instead of behaving like robots programmed to buy and sell mechanically on good or bad news. I think there is a bias that can develop because of the fear of that bias, which is an inability to recognize when you’re holding something great.  

We spend years studying these businesses, following their progress and watching the people involved make decisions.

Why not occasionally fall in love?

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