What's more important: The business or its manager? - AVNER MANDELMAN

Historians debate whether historical trends create leaders, or whether leaders create history. Similarly, some investors say a business's growth trend is more important than management, while others insist that good management can make any business grow. Why should you care about such a debate? Because the answer could show you where to focus your research: on the business or on management. So which is more important?

Warren Buffett - who certainly loves good managers - famously said that when a business with a lousy reputation meets a manager with a terrific reputation, the business's reputation stays intact. In other words, even a terrific jockey can not make a nag win a race. A strong business, Mr. Buffett said, can be run even by mediocre managers, just like a swift horse can win a race even when ridden by a ho-hum jockey.

That's one side of the debate. On the other hand stands General Electric Co., a company famous for training management talent. GE managers could not, perhaps, make a mediocre business win, but they could often guide it to a second or third position - at which point GE would sell it and buy a better one.

Is the answer, then, to look for a strong business run by strong management? This is too broad, because what is a strong manager? At each stage of a business's life, a different kind of manager may be required.
A run-of-the-mill competent executive may not be able to manage fast growth, while a headstrong entrepreneur suitable for starting the business may not be able to moderate his behaviour once the company has grown. Similarly, a grown company fallen into trouble needs a superstrong manager who, if brought into a stable company, could cause trouble by overactivity.

To take a historical analogy: Winston Churchill was often blunt, aggressive, impetuous, bullheaded, and made decisions on his own - all drawbacks in peacetime. But in wartime these same drawbacks became advantages and helped Britain win the Second World War. But right after the war, Churchill was voted out by the British voters, who correctly realized that these same qualities won't do in peacetime.

Turning back to investing, here are two historical business examples, then a current one of a stock Giraffe owns.

First is Yahoo. As Google began to make inroads into its market, Yahoo's founders brought in outside management talent - Terry Semmel, a successful Hollywood executive. But Mr. Semmel was the wrong choice. As our Silicon Valley informants told us, his Hollywood style did not sit well with Yahoo's geeks, which caused a slow unravelling in the top ranks and the stock began a steady fall. In other words, even a good manager can be the wrong fit.

Second example: Wavecom, a wireless products company with its headquarters in France. When its handset business declined, it got stuck with surplus employees who local managers did not dare fire.

An American chief executive officer then joined the company. As an American he was not beholden to French politicians and so he laid off two-thirds of the personnel and wrote off old products, which allowed him to invest in new wireless products. As a result, the stock rose from $5 (U.S.) to $36. Were the previous managers not good? They were okay; but they were suitable for running a steady ship, not for righting a listing one.

Now the third, current example: Nstein Technologies (EIN-TSX-VEN), a growing Montreal tech company whose stock, as was recently disclosed publicly, Giraffe owns. Nstein has search technology superior (in our view) to Google's -while Google looks at the myriad connections made by all other searches, Nstein's application understands language at the structural-grammar level. The company sells its product to online publishers, to help place the right ads alongside articles, and so increase the reader's response rate - and advertising revenues - meaningfully.

Sales are quick and customers are happy. Why then did we wait on the purchase? Although we have admired the company's technology and its entrepreneurial culture, and liked its growth, we judged that at this stage of life the company could benefit from further management. To their credit, the company's founders saw it, too, and on their own initiative brought in an experienced and successful CEO - Luc Filiatrault.

The moment he joined he began buying shares - as did several of his friends who knew his record. We did further due diligence, and within a short while invested also. Nothing is certain, of course, but we have good hopes for this combination of a good business and the right CEO - and good board, too.

What is Giraffe's answer, then, to the debate of relative importance of business or management? Like most investors, we think both are important; but we also insist on monitoring the manager's fit to the company's particular life stage.

Now how can this help you invest? Keep a list of strong businesses whose stocks are languishing because management no longer fits current business requirements. Wait until the suitable manager joins. Then invest. You may be surprised at the effectiveness of this simple rule.