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Why Culture Should Matter to Investors

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Research Analyst
Research, Cincinnati

“What is distinctive about your company’s culture?”

This is the first question I ask every company executive when I’m evaluating their firm for a potential investment. Their answer to this question often sets the tone for the rest of the conversation.

The culture question surprises some executives. “I’ve never had anyone ask me that before,” is a surprisingly common response. This, of course, could be due to the company having a rather dull culture, which is sometimes the case.

More likely, however, is that culture is not a topic that’s on investors’ and analysts’ radars. In my fourteen years in the business, for instance, I’ve yet to read a research report that has an in-depth discussion on a company’s culture. If you have, please let me know!

What is and isn’t important

When I ask management teams about culture, most of the responses are generic. “Well, we have a ‘can-do’ attitude,” they might reply, “and a tenured staff, so I guess people like working here.” That sort of thing.

Every so often, however, the CEO or CFO will perk up upon hearing the question and explain why their company’s culture is unique and – here’s the important part – value-enhancing to the business.

Corporate culture isn’t about having ping-pong tables in the break room, bagel Thursdays, or bring your pet to work days (though these may be a by-product of a good culture).

Instead, through this question, what I want to learn is how the company’s culture enhances its economic moat – that is, its durable competitive advantages. Most of the time, it’s the simple things – not the lavish employee perks – that signal a healthy, value-accretive corporate culture.

All adds up

To illustrate, U.K. insurer Admiral Group, which prides itself on being a low-cost operator, required employees at its new U.S. subsidiary to do a push-up or yoga position for each piece of paper they printed at the copier.[1] At face value, this may seem like a silly game, but it helped set the tone in the new office that Admiral cared about all costs. If successful, these efforts will help Admiral retain its low expense ratio relative to insurance peers and keep rates down for customers. 

Similarly, Costco Wholesale’s employee turnover rates have been well below the retail industry average. One reason for this is that Costco pays hourly employees above-average wages, with many receiving health benefits.[2] And while these extra expenses might pressure Costco’s short-term margins, they add long-term value to the company by retaining valuable institutional memory, improving customer service, and reducing hiring costs.

As Warren Buffett noted in his 2005 letter to Berkshire Hathaway shareholders, the little things that companies do each day matter over time:

If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength…On a daily basis, the effects of our actions are imperceptible; cumulatively, though, their consequences are enormous.

When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as “widening the moat.”[3]

With investors, analysts, and the financial media clamoring over quarterly earnings, it’s easy to see how these incremental changes get overlooked.

Bottom line

Culture matters to long-term investors precisely because it empowers the company’s employees to do their day-to-day tasks just slightly better than its competitors. Over time, these little advantages compound into much larger advantages, which can persist far longer than conventional wisdom expects.

Stay patient, stay focused.

Todd

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Footnotes

[1] https://insurancenewsnet.com/oarticle/Elephant-Insurance-could-become-major-employer-%5BRichmond-Times-Dispatch-Va%5D-a-223456

[2] https://www.costco.com/about.html

[3] http://www.berkshirehathaway.com/letters/2005ltr.pdf

(Cover picture: David Teniers the Younger – Gallery of Archduke Leopold Wilhelm in Brussels  (1651))

Disclaimer

Todd Wenning is a Research Analyst with Johnson Investment Counsel (“Johnson”).  He owns shares of Admiral Group, Costco Wholesale, and Berkshire Hathaway Johnson clients own shares of Admiral Group, Costco Wholesale, and Berkshire Hathaway.

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