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The Importance of Culture in Investment Analysis

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In my time doing stock research and analysis (albeit a relatively short time I have to admit – as compared to other analysts), I’ve come to realize that “culture” has been heavily downplayed in favor of more tangible metrics such as ROIC or debt levels.

The rationale is simple: People like things that can be quantified. It gives analysts and stockholders a sense of security.

But what people rarely question is: “What drives those numbers?”

Yes, a large part in a company’s financial growth can be pointed to industry trends, more demand, larger opportunities, etc… But what’s arguably equally important is the underlying company culture that powers those workers to produce better and better profits every quarter.

As investors, we are interested in the long-term prospects of companies. Culture plays a huge role in determining whether a company succeeds extraordinarily well or manages to scrape the bottom of the barrel over the long run.

Culture is hard to qualify, let alone quantify. It isn’t something an investor can quickly pick up – as compared to, for instance, the charismatic qualities and actions of a visionary CEO such as Steve Jobs or Mark Zuckerberg.

It’s subtle. But with a keen analytical lens, an investor can learn how to identify a winning company culture that will drive growth (and earnings) in the long-term.

Things to Keep An Eye For…

  1. Glassdoor Reviews and Ratings. The most fundamental “gear” of a business is its employees. If the gears are rusty (and cranky), then you know you got a machine that’s not running at optimal performance or needs huge continuous “repairs” (high re-staffing costs) to keep it running well. One way to check the quality of employee satisfaction is through reading reviews on Glassdoor or any industry-focused job forum. Keep a special lookout for comparison between the company you’re analyzing and a close competitor. That will reveal a few tell-tale signs about the company’s work environment.
  2. Physical Checks and SOPs. Another clue about the company culture is to physically visit their stores/outlets, and see if ground employees clearly know the purpose of their organization. For instance, Uniqlo employees follow a set of cult-like principles, one of which where each customer is greeted when they first enter the store. This is followed at every store – regardless of language or country. While it seemingly doesn’t directly value-add financially to investors, it created a long-run brand awareness for consumers – which helped Uniqlo successfully compete with major fashion retailers like GAP and H&M. It’s phenomenal growth is not by accident – but by a strong culture with a focus on innovation and great customer experience. Any slippage from their normal procedure would result in decreases in customer satisfaction, which harms market share in the long run.
  3. Employee Autonomy & Decentralization. Another part of high employee retention and satisfaction is a strong focus on giving meaning to each employee through their work. Workers feel valued when they don’t feel like they are just a cog in a huge machine. The best example of this is Berkshire Hathaway. One key criteria for Berkshire’s M&A is that the existing management can and should continue to stay on. Buffett or Munger will never interfere with the existing management regarding their day-to-day operations, nor question their managerial decisions for bolt-on acquisitions, new ventures, and the like. In Google, we also see this pretty clearly. Employees are given 20% of their work week as free time to come up with new ideas and innovations in an initiative called “20 percent”. Without this, Gmail or Google Maps wouldn’t have existed and subsequently made Google the Internet giant that it is today.
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Of course, this isn’t all there is to evaluating culture. It isn’t meant to be, anyway. Culture is something you innately experience being in the company or the experience leading up to (and after) the purchase of the company’s products or services. It cannot be figured out by looking through the financial statements or going to their AGMs.

Ultimately, the key focus is on the employees. When employees are encouraged to be creative and take pride in their work, it emanates and flows through to the customers. Customers feel it. Managers also feel it – productivity and bottom line increases. It’s a win-win for the company. That’s when you know the company culture is working.

Conversely, disgruntled workers lead to high employee turnover, worker strikes and operational inefficiencies. Costs take a hit and management resorts to all sorts of quick-fixes, the worst being accounting manipulation to satisfy the Board and shareholders. This is what might happen if a company has a weak culture.

Hopefully I’ve convinced you that culture plays a big role in investment analysis. What is seemingly so intangible ultimately results in 80% of the tangible results. Investors would fare better looking at culture in their investment process.

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