Tuesday, August 24, 2010

How to identify a truly great company from a merely good company

In a post back in Dec. ‘09, I had mentioned that the great companies can be distinguished from the good companies by how efficiently they use the money invested in the business to generate higher profits. The post was an introduction to a short series of articles on financial efficiency and profitability ratios.

At that point of time, I had not heard of, or read anything by Jim Collins – the former award-winning teacher at the Stanford Graduate School of Business. In his 2001 book, titled “Good to Great”, Collins has distilled and analysed the results of a 5 years long research project undertaken to identify how merely good companies become truly great companies.

Collins and his team of research associates sorted through all the published information available on more than 1400 US companies, and held countless interviews and discussions to come up with a short-list of 11 truly great companies.

These companies were merely good for many years before they were able to produce sustained great results over a period of 15 years, and significantly outperformed bigger and better known competitors in terms of stock market returns.

The outperformance period of 15 years occurred during the 1970s, 1980s and 1990s – just prior to the dot.com boom and bust. Some of the companies are no longer great companies, and some are almost down and out.

The book is a good read nevertheless, and reveals some universal and timeless principles that can help us to identify (and invest in) the truly great companies in the Indian stock markets. Here is a gist of the principles:

1. The transformation from good to great doesn’t happen suddenly. It is a process of a gradual build-up followed by a breakthrough.

2. Unlike the popular perception of how companies are turned around by high-profile leaders with rockstar-like personalities and egos, the good-to-great leaders are self-effacing, quiet, reserved, and have strong personal integrity. Such leaders ‘are a paradoxical blend of personal humility and professional will. They are more like Lincoln and Socrates than Patton or Caesar.’

3. Good-to-great leaders make sure that they select the right people for the right jobs, and spend most of their time on team building and succession planning. They don’t take the credit for the outperformance of their companies. They give the credit to their team.

4. Once the entire team is on board and the vision and strategy have been agreed upon, there is complete faith in the eventual success – and at the same time, the discipline to confront and overcome adversity and changes in current reality.

5. The good-to-great companies have a culture of discipline – disciplined people, disciplined thought, disciplined action. The culture of discipline combined with an ethic of entrepreneurship produces great sustained performance.

As I was reading the book, the first name that flashed across my mind was ‘Narayanmurthy’. He epitomises all the principles mentioned about good-to-great leaders, and led Infosys to become one of the truly great companies. The succession planning in the company has been an example that others should emulate.

Ratan Tata (Tata Steel, Tata Motors), Anand Mahindra (M&M), Yogi Deveshwar (ITC) are some of the names that also come to mind. Disciplined investing in these companies can generate enormous wealth over the long-term.

I am sure there are several other names that readers may know of.

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