Motley Fool Hidden Gems Investing - How to Evaluate a CEO

Episode Date: March 28, 2023

Before you buy shares of a company, what should investors look for in a CEO?   (0:21) Bill Mann discusses: - Alibaba announcing its intention to split into 6 separate companies - Whether Amazon and Alphabet are discussing (or hearing from investment banks about) the same thing - Why he's watching where these companies raise money for their eventual IPOs  (11:05) Alison Southwick and Robert Brokamp talk with Asit Sharma about his framework for evaluating leadership. Companies discussed: BABA, ASML, AMZN, GOOG, JD, T, NOW, NVDA, SFIX, DOCN Host: Chris Hill Guests: Bill Mann, Alison Southwick, Robert Brokamp, Asit Sharma Producer: Ricky Mulvey Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. Big Tech is back in the spotlight. Motley Fool Money starts now. I'm Chris Hill. Joining me in studio, Motley Fool Senior Analyst Bill Mann. Thanks for being here. It's a beautiful day in the neighborhood. How are you doing, Chris? It is a beautiful day in the neighborhood, especially if, and I'm not one of these people, if you're an Alibaba shareholder. Because for those who missed it, the $250 billion Chinese e-commerce company announced it is going to be breaking itself up into six separate businesses. They are, in no particular order, cloud intelligence, online shopping, local services, logistics, global commerce, media and entertainment. Shares of Alibaba are up 11% at the moment on this news.

Yeah. There are a few things I want to get to, but let me just start with what was your reaction when you saw this news? Well, the first thing I thought was, isn't it interesting that a couple of things are happening at the same time? Jack Ma, the founder and face of Alibaba, although he's not the CEO anymore, goes back to China for the first time in a year. TikTok is in the midst of perhaps being thrown out of the United States of America. And suddenly, Alibaba has come up with a plan to break itself up. Need I say more? I can go on.

Yeah, say a little more. So if you just – I always want to be careful not to read too much into share prices, especially in the short term. even though the stock is up 11% today, it's still down about 75% from its all-time high. And China has, over the last five years, proven to be very unfriendly to its tech businesses. I think the government really found that they were becoming their own centers of power and it was nervous about that. But China finds itself now looking at places where things are working for it and where things are not working for it. So they have a Belt and Road Initiative, and what they're ending up having to do is bail out a bunch of governments and a bunch of countries around the

world that they've loaned money to at rates that they probably shouldn't have. They have a global embargo for certain high-tech equipment. So the Chinese foreign minister met with the head of ASML, which is a giant Dutch chip fab-making company, I believe, yesterday. The one thing in China that really seems to be working is their consumer tech businesses. And so I think that there's been a rationalization and a realization that they need these companies to perform well. And so this is why you see Jack Ma feeling very comfortable going back into China. And this maybe is why you now see Alibaba taking this opportunity to break itself up. One reaction I had just in terms of the stock was I'm sure there are some people bidding this up because they are bullish on the idea that, hey, if this company splits itself up and I get six separate businesses, that's going to pay off for me more down the road.

Is it set in stone that this is the path for, like, all six of these are necessarily going to be public? No, it's not. So basically what Alibaba is being broken into right now, it's not a perfect comparison, but basically what Alphabet is. So you've got the holding company, which is the publicly traded entity, and then underneath it it's got Google and it's got all of the other different components of their business. So it will be similar to that, although every company will have its own P&L, it will have its own management team, it will have its own capacity to go out and get capital. Now, the cynic in me, and the cynic is strong with me, says that this is at least partially a play for Alibaba to start to generate huge amounts of funds coming from investment banking. You know, so suddenly Alibaba has gone from being the company that everyone was nervous about to a company that everybody's excited about again. So you know there is a little bit of a song and dance on Wall Street now.

You're getting ready to see, I predict, some really, really aggressive price targets as these investment banks start to set themselves up because it's not just one company anymore. It's six that want to tap the U.S. markets for funding, which is what having a stock symbol on the New York Stock Exchange or on NASDAQ gets you. So, yeah, so the cynic in me looks at this and says, OK, this is China actually turning and recognizing that they need to put their best foot forward. And their best foot actually does come in the form of Alibaba and Tencent and Baidu and their very, very powerful, popular consumer tech companies. Let's just say for the sake of argument that all six of these do go public. Are there areas of the Alibaba empire that interest you more as an investor than other areas? Taobao, I guess you could – it would be somewhat dismissive to call it a PayPal because it's much bigger and much deeper than that. You know, it's interesting. I don't know that people who are outside of China recognize just how much credibility e-commerce has in China and just how deep into the culture it is and just how deep into the economy it is.

you know, uh, companies like JD.com and even, you know, even at, uh, some of the Alibaba subsidiaries, you can order things like fresh fish and get them delivered to your house in 30 minutes, which is not something I don't know. I'm not going to Amazon and asking them to, to deliver perch to me and expecting it to be anything other than disgusting. So there are elements of this business that are so deeply ingrained in China that, yes, having the opportunity for them to be broken out and having investors potentially have the ability to invest just in them actually really does interest me. Let's move it back to the United States. It's easy for me to imagine that this announcement from Alibaba has set off a series of conversations,

whether they are coming from within tech companies like Amazon and Alphabet or they are coming from the investment banks. But the conversation goes something like this. Well, that's interesting. What if we did that? Or if you're the investment bank, hey, Alphabet, do you see what they're doing? Have you thought about maybe not six companies, but have you thought about what YouTube is worth if you just spin it off?

Have you thought about Amazon taking that web services business? Have you thought about that? Because I know we haven't asked you in a few weeks, but we're asking today. The few weeks being the key part. The question is, to whom does that benefit fall, right? So I think that we could probably say that the Alphabet management team is rational. And I think that we can say that the Amazon management team is rational. And so they certainly have considered breaking up the companies before restructuring.

In fact, Alphabet went down that road and then went just as far as setting up a holding company. It would definitely, absolutely, positively benefit the investment bankers to do this business. And so I'm sure they will continue to ask. There are actually some examples of breakups that have happened in the U.S. You can go back to Standard Oil being broken up into a bunch of regional oil companies as well as services and delivery companies. And then maybe the better example would be AT&T in the 80s when Ma Bell was broken up. And there were certain things that were beneficial. You know, things like caller ID, they'd had that technology for 40 years and it never occurred to anybody that maybe somebody would like to know who's calling.

But then on the other hand, it made a system that was very simple, very complex. You remember like the dial arounds and it actually really harmed the Bell Labs, which is one of the crown jewels of of American commerce. And so Bell Labs was never the same after that. So I think that there is a very different environment here in the U.S., and there is some benefit to having those companies have larger asset bases, especially in terms of research and development. Though I'm sure, if you're as cynical as I am, those calls are going to keep coming in. What's the thing you're going to be watching over the next few weeks as this story evolves? uh next couple of weeks i don't know that there's going to be that much change i think it's going to be over the over the course of a year or two and you're going to start to see some of these

companies how they are going to operate as functionally independent companies what type of capital they would be raising where the capital would be raised and i think that the tell for what the end goal is is that actually that last part if they're raising in hong kong then i think you can say that China is still committed to building its own internal markets. But if they come to New York and they go to London, it's a cash grab. And you have to know that what they're selling comes at a point in time in which we as investors ought to be skeptical. Bill Mann, always great talking to you. Thanks for being here. Thanks, Chris.

before you buy shares of a company what do you look for in the ceo allison southwick and robert brokamp talked with asit sharma to get his framework for evaluating leadership someone once said buy stock in businesses that are so wonderful an idiot can run them because sooner or later, one will. That's always a sign of a good quote when you can't immediately figure out who said it. The internet tells me maybe it was Buffett, Munger, Lynch, no matter. I'll bet bro knows the truth of it. Bro, do you know who really said it? Oh, you don't. I always thought it was Warren Buffett, but you know, that or Shakespeare. Shakespeare might've said it.

Maybe. All right. But what stands out to me about this quote isn't the whole buy wonderful businesses part. It's the inevitability of an idiot at the helm. It makes it sound like there's this line of dumb CEOs just waiting their turn to run a business? But I mean, didn't CEOs get to where they are by being smart and hardworking? Okay, okay, I can hear you snickering in the back of the classroom, listeners. Now, if you will, imagine a company where a business could be run by an idiot, but it's run by a really smart person. Now that is a business to invest in. Joining us today to explain how he evaluates CEOs as part of his investing process is Asit Sharma. He's an analyst with The Motley Fool, specifically stock advisor. Asit, thanks for joining us.

Alison, bro, thank you for having me. Now, of course, being a successful CEO isn't just a question of smarts and whether you're an idiot or not. It's actually much more complicated than that. Right, Asit? Yeah. Alison, it matters because, like it or not, the CEO is the one creating the framework for success or failure in the company. The CEO is bringing in the people, building the culture, the systems, figuring out which products or service innovations are going to drive growth going forward. A great CEO is going to create an organization that will flourish long after they leave the scene, as you've already intimated. Conversely, I've seen CEOs who are simply

mediocre. I mean, not even bad, just mediocre, and they diminish the value of a company that I've invested in. Why? It's complex. You're looking for a leader who brings an enormously broad skill set. I think we're going to talk more about this in a moment. It has the experience and instinct to choose which tool to use, which is the best tool in each situation. Adding to this complexity, you're also looking for flexibility of thought and emotion. To me, the best CEOs are good at mastering what I call opposite skill pairs. I'm just going to give you a few examples rather than trying to explain this to you. Think of Steve Jobs, former CEO at Apple who unfortunately passed away at a young age, unmatched as a visionary, but was relentless in execution.

Satya Nadella, the current CEO of Microsoft, he exudes compassion. I don't know if you ever watched a video of this guy talking, but he just seems like such a nice guy. But he's unafraid to make tough and sometimes really painful decisions. Two more examples, Indra Nooyi, who was the former CEO of PepsiCo. She is a master of project analysis, all those complex net present value calculations to see what's going to bring in money and what you should pass on as someone running a big investment or project. But she is even better at gut decisions that eventually often have higher payoffs than the projects where she crunches the numbers. Finally, Bill McDermott, who is CEO of ServiceNow. This is a leader who understands that his company

in the place that it's in its market needs speed. He's relentless in pushing this organization, but he's unwilling to shortcut by acquiring other companies. So he exercises a lot of patience in how they build their company. So once you get a feel for these types of, I'll call them personality types, it becomes easier to spot the hallmarks of a strong CEO, in my opinion. All right, awesome. So you have a checklist for evaluating leadership at a company. Let's go through each briefly. And then also, if you have any specific examples of CEOs who really hit it out of the park in any one of these aspects, feel free to name check them. So, all right. First one we're going to talk about is the fit. What is that?

Yeah. So, the fit, Allison, is just a framework that I have mentally to try to figure out if a CEO, whether the CEO is a founder or not, is the right person for a particular company in the present timeframe, given what the challenges on the ground are, but also looking into the future. What are the current opportunities versus long-term opportunities? What are the current risks versus the long-term risks? You could be a really great CEO for a company, but not at this particular time. Here's an example. Let's look at Stitch Fix. Their former CEO, Katrina Lake, was a great founder-CEO. She was great leading the company through its first phase of growth. After that, they needed someone else with a different skill set to come.

Unfortunately, the person who they hired to come on board left the company. Katrina Lake came on back in a temporary capacity. But from its founding through the IPO phase, with her vision, with her technical skills, and her ability to inspire her employee base, she was the right CEO at that point in time. Her fit level was great. Here at The Motley Fool, we do tend to often like founder-led companies. But it does seem like, as a founder, you do need some of those visionary skills. And maybe at that early time in a company's business, you need that sort of visionary, inspirational type person. But then later, you maybe need more of an operational person or a battle-tested CEO. Yeah, that's very much true. And as

investors, we tend to get stuck sometimes in this game. And we play it with our friends. I like you so much, Allison, that if you do something that I just see as totally wrong, It may take me two years to tell you, like, hey, I don't think you should have done that. The same way with CEOs. We tend to fall in love sometimes with CEOs, even when the best course of action for a company might be to transition that founder CEO into another role, let's say, the person in charge of the strategic product map, and bring someone else in. All right.

Next up, you have background and skills is something you evaluate. That sounds kind of broad. How do you do that? It's not easy. You want to make sure that the person who's the CEO of a company you've invested in has some sort of product background, if possible, in what the company is succeeding with in the marketplace. Sometimes, you get CEOs who've been brought into a company, but they're from a completely different industry. To me, that's always a yellow flag.

The skill set, we can talk about this a little more as we go down the list, but it should be broad. a great CEO is not going to be someone who's only good at a few things. He or she or they should have a really broad palette, which they can draw on. I talked about this a little bit earlier. And relevancy. You want the relevant background and skills to the mission you're accomplishing at the company you're in right now. An example that comes to mind here is Yancey Sproul, who is the current CEO of DigitalOcean. Now, in his previous iteration, he was the CEO of a fast-growing company, which was eventually acquired by another publicly traded company. He's got a background and skills in growing a very small software as-a-service organization

into something pretty large that was acquired by an even bigger fish. Again, this is going back a little bit to Fit. He's got the background and skills that are relevant here for Digital Ocean, but he's also a good fit for the company at this point in time. You highlight something I've seen a lot over the years, and that is an executive who's successful with one company coming over to another company, and it just doesn't work out. And a lot of it is just what you said. They really weren't skilled in this new business that they're taking over. But some of it is also culture. They just weren't aligned with the culture. Do you have a feeling or a preference for companies that hire from within versus

going outside to get fresh ideas? Personally, for me, I always think it's better if you have a strong candidate who's come up within a company's culture for that person to take the reins, because they already understand what will resonate with coworkers, with people in the C-suite, with the board. They already have a sense of what's the most fruitful path of action to take in big-picture decisions. That's not to say that sometimes the recipe of bringing in an outside CEO isn't the greatest thing you could do. Sometimes you need that splash of fresh energy and a fresh perspective, and someone to say, we've got it course-correct But my preference certainly is, especially if the culture is strong, preserve that culture.

That's what's making you great. I have spent my working life looking at numbers. The more I look at numbers, the more I realize it's the people that drive the numbers, not the other way around. So you can have great people, the numbers will fall out in the wash. All right. The third aspect we're going to look at is the intangibles. Yeah. So this is maybe the hardest in my framework for me to evaluate. And I would suspect with other investors, it's also difficult. Some of the things I listed in the notes we traded on this when we were prepping for this is, okay, passion. I'm reading these now and they looked so difficult. Charisma, authenticity, ambition, emotional intelligence, BS factor. Getting a

read on the character and leadership chops of the CEOs is necessarily difficult, right? Because these are salespeople. They are selling you their vision. They are selling you their abilities. They are trying to have you invest not just your dollars, but your confidence in them. So, best CEOs have this weird mix of being able to pull off this swagger, but be authentically humble at the same time, and be a little self-critical. When you try to do all three of those at once, it's really, really hard. And so, I like to see a little bit of imperfection in the mix. I, as most people, shy away from the person who comes across as just overly slick and just hugely charismatic. That's a yellow sign or a red flag. I like to see a bit of

the stumble and the struggle. One CEO who comes to mind, who I may talk about later, is Jensen Huang. He's the CEO of NVIDIA. He just gave the annual keynote speech at NVIDIA's Investor Day. More than that, it's their tech conference. He's not the greatest public speaker in the world. He's talking about these high-tech concepts, and he's getting into these gnarly details. And sometimes it's a struggle to keep up with him, but he's authentic and you can tell that he is really, really passionate. So I probably made this seem like really, really hard and it is the intangibles, right? Yeah, the intangibles. If they were tangible, they wouldn't be difficult.

Yeah. No, it does seem like to be a successful CEO, you do need, like you said, to have that sort of like salesman sort of skill to you. But then that could also just leave a lot of people who potentially could be great leaders on the sidelines because they just didn't have that swagger. Maybe they're really intelligent, but they just don't have that skills that make people naturally want to just follow them and become inspired by them. That is a very tough pocket to get into. The Venn diagram of that is probably pretty small. All right, Asit, so far, we have covered the fit, part one, dun, dun, dun, a little foreshadowing there, background and skills and the intangibles. But we are not done yet because we have more factors on your checklist

for evaluating a CEO, and we will get to them next week. Asit, thanks so much for joining us, and we'll see you in a little bit. Thank you, guys. I'm looking forward to it. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.