Looking back at the companies I’ve been most interested to invest in, I’ve found a pattern where I subconsciously favour businesses that are holding companies or have multiple, independent lines of business.
In a business with multiple operating enterprises, I instantly feel that these are safer organizations because their structure can act as a hedge in case any one of their ventures goes belly up. Incidentally, it can also act as a way to siphon capital from one thing to another when it’s most opportunistic to do so.
If we pear back a bit, all corporations in fact inherently have multiple lines of business (in my opinion). They continually need to allocate capital somewhere, even when it is cash or cash equivalents. In cases where companies choose to invest in marketable securities, you can make the case that that really is another line of business, just not one that provides direct managerial control.
The result might be a company with multiple “tentacles” or “branches”, but the nature of a company with multiple lines of business that have existed under the same corporate umbrella for a long time (and with good numbers) signals that management at least knows (or is forced to think) about trade-offs to allocating capital.
At worst, it allows management to direct funds to an operating company that they fully control (though it may not be the best capital allocation decision to make), rather than park it in low-interest cash or make poor choices in non-accretive share buybacks or special dividends to shareholders. Though neither of these are true guarantees of mis-management of capital allocation decisions.
In one of Nick Sleep’s letters when he was running the Nomad Investment Partnership he talked about how (that year) he learned something new when doing a research trip a Welsh insurance company. He changed his mental model a bit when management had told him that even though they sell a commodity and fiercely competitive product (auto insurance) that they have been very successful and profitable over decades because they did not do just one thing better. They did a whole lot of little things just a bit better than their competition and that was their competitive advantage.
I know Sleep is talking about his famous concept of Scale Economics Shared, but when I was reading this I couldn’t help but apply the following paragraph and have it also applicable to companies that have multiple lines of business (too).
“Guessing which-branch-next [of where to focus investments in a single operating business] can be a crowded trade, but it’s fine, as far as it goes. However, it rather misses the big picture, in our opinion. We would propose that some businesses, once they have progress down the first favourable branch, stand a much greater chance of progressing down the second favourable branch, and then the third, as a virtuous feedback loop builds. The process tasks time, but a favourable result at any one stage increases the chances of success further down the line, as it were. Think of it as a business’ culture.”Nomad Investment Partnership Letters, Nicholas Sleep
Again, Sleep’s realization here is primarily focused on working out why this Welsh auto insurance company was successful or looking back at Amazon or Costco and understand another dimension that made them so successful. But I think it applies more generally to not just a company that has a singular line of business where the operator is optimizing various parts of the value chain, but that it speaks to the capacity for the management to be able to know when it’s good enough and pack up, move on and allocate capital to the next thing (be it the same or different business lines).
After all, all businesses and/or products asymptotes (after a time and hopefully not for a long long time), but it takes good judgement of a great business operator to know when to maximum the return on investment be it in the current business or other current (or future) businesses.