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Real due diligence starts after investing
Outsiders and insiders
Public investors, venture investors chasing deals, and experts in an expert network are all outsiders looking in. The first board meeting after an investment changes that, and buyer's remorse often arrives with it: this is what is really going on.
Once the founder opens up, the investor becomes an insider, though one who knows far less than the founder does. Both sit on the same side of the table as owners and business partners, working out whether it is a good business and where to deploy capital.
Capital allocation
The best CEOs become great capital allocators over time. Early on, that means resource decisions, such as hiring another engineer or a sales rep, or building out data centers. Later it includes acquisitions, dividends, stock buybacks, and tender offers. Compounding over years and decades depends on those decisions.
It runs both ways: Buffett is a better investor because he thinks like a businessman, and a better businessman because he thinks like an investor and a capital allocator.
Why does an insider see more than an outsider?
Public companies disclose their results through filings such as the quarterly 10-Q, which are written to be general and legally careful. A board member sees monthly detail, internal disagreements, and plans that never appear in a filing. The information gap between those who run a company and those who invest from outside is one of the oldest problems in finance. Economists call it information asymmetry.
What did the best CEOs do with capital?
William Thorndike's 2012 book The Outsiders profiled eight chief executives who delivered returns far above the market over long tenures. They included Tom Murphy of Capital Cities and Henry Singleton of Teledyne, both known for allocating capital unconventionally. Singleton bought back large amounts of Teledyne stock, which was unusual at the time. Thorndike's book credits their choices on where to put cash more than operating skill alone.
How do dividends and buybacks differ?
A dividend pays cash to every shareholder in proportion to their holdings. A buyback uses cash to purchase shares, which reduces the number of shares outstanding and raises each remaining share's portion of the company. In the United States, buybacks became widespread after the Securities and Exchange Commission adopted Rule 10b-18 in 1982. Before that rule, companies worried that repurchases could be treated as market manipulation.
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