A Managerial Approach to Investing

Nov 2, 2009 by Adam C. Powell, Ph.D.

You may have noticed that I never seem to talk about P/E ratios, candlestick charts, or other quantitative measures of performance. I don’t mention them, as I use a different type of criteria to make my investment decisions. As a person trained in management, I evaluate the potential performance of companies using qualitative managerial criteria. Management theorists developed the “Resource-Based View,” which declared that for a firm to have a competitive advantage, it had to have resources which are the following:

• Valuable
• Rare
• Inimitable
• Non-substitutable

Some firms outperform others as a result of having resources, which are a source of competitive advantage. During the pre-election peak of the financial crisis, Goldman Sachs had a “resource” that potentially gave it a competitive advantage. That resource was Henry Paulson, the Secretary of the Treasury, and former CEO of Goldman Sachs. While one will never know if he provided Goldman Sachs with excessive favor as a result of his experience with the firm, that experience certainly gave him a stronger understanding of the effects of his decisions on the firm than he would have had for other banks. So, was Hank Paulson a resource? Well, if he could advocate for favorable legislation, that would make him valuable. His abilities were relatively rare in that few other people had such a prominent role in determining financial policy, save for perhaps the President and Ben Bernanke. Likewise, he was inimitable. During his period of tenure, there was nothing any other bank could due to produce an imitation Secretary of the Treasury. As for being non-substitutable, other banks might have been able to substitute their connections with other officials for Goldman’s connection with Paulson. Nonetheless, there was nothing that the other banks could do to change this situation until after the election. So, it appears that Henry Paulson was a potential source of competitive advantage. All things being equal, firms with more numerous and stronger competitive advantages are likely to outperform firms with fewer and weaker such advantages.