When it comes to investing, two very important factors will improve your level of profit taking.
The first factor is a margin of safety.
That means that you want to buy a company with close to zero chance of experiencing life-threatening financial distress. You also want to get more than you pay for, as that makes it easier to tolerate the often ridiculous short-term behavior of the markets.
The next factor, a very close second, is the idea of skin in the game.
Skin in the game is the ultimate measure of accountability for a company.
It means that when you buy a company, you want the people running it to have a large stake in it – at least a stake large enough to matter when things go well and large enough to hurt if they screw up.
It they don’t have a large stake, it’s as if they have a multimillion-dollar golden parachute. And if business heads south, you’re the one who is going to pay – not them.
Here’s How to Detect Zero Skin in the Game… Before a Bad Ending
We just saw a great example of what can happen when players have no skin in the game.
During the recent shut down – and the ones likely to follow in a few weeks – all the major decision-makers had no skin in the game. All of the political leaders involved are reasonably wealthy, and their paychecks never stopped flowing. It cost them nothing to take a hardcore negotiating stance because if no deal was reached, it didn’t hurt them a bit.
The people who were trying to feed their kids and keep the lights on with no paycheck had an enormous amount of skin in the game but no seat at the table.
A lack of skin in the game played a huge role in the 2008 financial crisis as well.
All the fees and bonuses earned by Wall Street executives, mortgage brokers, and other bad actors selling the toxic crap that almost blew up the financial system, stayed right where they were.
The firms and their employees suffered, as did their clients. Even innocent bystanders got crushed. But the executives and salespeople kept all those ill-gotten gains right where they were – in their pockets. They get rich if their motives succeed, but paid no price when they failed.
And we see this play out in corporate America too.
Take a CEO that owns very little stock. If he screws up and gets fired, he has no skin in the game. As long as he or she does nothing illegal, there is no way they don’t walk out the door with more money than when they came in, no matter how badly they screw up or how far the stock declines.
The shareholders pay the bill for management mistakes. They are the ones who have to watch in misery during a steep stock decline.
So one of the greatest ways to avoid bad investments is investing in companies where there’s lots of skin in the game
If a CEO has lots of skin in the game, then he will work his butt off to ensure that his company’s stock succeeds for you.
And he has to. Because if he didn’t, and if the business went south, his tail would be on the line just as soon as yours would.
But let’s take a closer look one company that proves the importance of skin in the game …
To Identify Skin in the Game, Follow KKR’s Private Equity Approach
Skin in the game is something that the folks at private equity giant KKR and Co. (KKR) have understood for a very long time.
When they do a buyout deal, they allow management and even the lowest level employees to participate in the deal and own stock in the company. They want to make everybody an owner. Owners focus more and work smarter than employees. KKR has conducted case study after case study, which show that this has been a very successful strategy and made a lot of employees far wealthier than ever could have from just collecting hourly earnings.
But how do we identify companies like the ones KKR picks? Simple…
Many investors say that the first thing they do when investigating a company is read the annual and quarterly reports filed with the SEC. However, throughout my 30 years of experience, I have met very few who actually do it, even though everyone says it.
I go to the annual proxy filing instead to see how much stock the insiders own. If that number is too low, I begin to lose interest very quickly. No matter how good the company may appear, I’m not willing to invest if the top folks are going to get dirty stinking rich if it succeeds and not lose their butts if it fails. I am not willing to sit on the opposite side of the table from them as a shareholder.
I have tracked and tested the concept of skin in the game for a long time. When you combine that with buying good companies at bargain prices, you beat the market rather handily with a lot less risk (as measured by portfolio beta) than even just owning a plain old index fund.
Skin in the game makes sense. If everything works out, we all make money. If it blows up, I want to look around and see the senior executives under the kitchen table sharing my bottle of cheap tequila. I want to always be in a situation where if the insiders want to get richer, and have to make me richer right along with them.
Only Buy Companies with Skin in the Game… Like This Heatseekers Pick
Buying companies with skin in the game and CEOs who will work their butts off is exactly what we’re doing in Heatseekers.
And it’s especially the case with our recent addition to the Heatseekers portfolio.
The CEO personally owns about $9 million of stock. More than 90% of his annual pay exists in the form of stock granted to him if he meets the goals of his incentive plan. The only measurement in that plan is total shareholder return. To earn his full pay, he has to do all the things that will increase profits, push up the dividend payout, and drive the stock price higher.
If he doesn’t make us money, then the value of his stake in the company goes down and his pay can decline by more than 90% in a given year. That’s skin in the game.
If you’re not already a Heatseekers member and you want to learn how to gain access to extraordinary company with skin in the game, click here.
To the max,