Two months ago, I visited BookExpo America, the annual publishing industry gathering, to schmooze booksellers and sign copies of my latest book. No, not Sleuth Investing II, but a mystery-thriller I began years ago called The Debba. The Javits Center in New York, where the shindig took place, was bustling with thousands of people - book sellers, company administrators, marketing managers, PR personnel, CFOs, printers - all important to the publishing business.
Here and there you could also see a sprinkling of bashful authors signing copies of their latest books, accompanied by their publishers or editors. These two, author and editor, are the centre of the enterprise. They are the sparkplugs that light the fire under the reader, with the book that all the others manage, market, and sell.
So it is in many other industries, though you wouldn't know it from talking to analysts covering them.
I am a believer in due diligence beyond the numbers, especially when it comes to a company's people. I don't simply mean management; I also mean the company's sparkplugs. Every organization, like every car engine, has them. They can be hidden, they may not look like much and may not have outgoing personalities, but without them the corporate engine is a dead hunk of metal. Unless you know where to look, you may not even find them. And even if you do know, unless you are an expert mechanic, you may not know the difference between a normal sparkplug, and one used in, say, car racing, that can improve performance significantly.
This is particularly true in companies involved in creative endeavours, where the fruits of the human mind and heart are the product's raw material. The obvious cases are well known: Howard Stern's draw for his satellite radio employer: J.K. Rowling, who made zillions for publishers of her Harry Potter books; Jerry Seinfeld's show, which also made hundreds of millions for its corporate partners. Smaller-scale sparkplugs often remain unknown, but they exist in most TV or movie production companies - or in well-managed book publishers, or in tech companies, in particular software-based enterprises.
In such companies, return on equity is often high, the cash flow generous, and beginner analysts may attribute them to the "niche" or the "brand" or the "market segment." Although none of these can be discounted, the fine results are often due largely to the brilliance of a few individuals hidden well inside the company, whom outsiders rarely meet. Just as often, if these sparkplugs leave, within a short period the profits plunges and the stock swoons.
How to distinguish the sparkplugs from the merely shiny metal?
When I ran stock research departments on Bay Street, this was a key question. Some analysts were the finest human beings, knew the CFA curriculum by heart, could construct spreadsheets in their sleep, and could charm you with their talk. But they could not pick stocks if their lives depended on it. Others got into frequent tiffs, didn't use the Queen's English properly, and didn't care what you thought of them. But they could pick stocks that made money for the clients - and us. Because salespeople usually claimed the best ideas were originally theirs, clients were not always the ones who knew. The best way to find out which analyst was truly good was to talk to other analysts. They knew.
So it is in most creative endeavours, whether stock picking, circuit designing, software writing, or book editing and publishing. Beyond a certain point, skill rises to the level of artistry, and the ones who understand it best are others involved in the same occupation. It is extremely hard for outsiders to dig out such info. But when the sparklers are the main source of a company's profits, this is an effort you must make.
Take Apple. When it lost Steve Jobs, the company and its stock went into a tailspin. Pixar, on the other hand, where Mr. Jobs went to (and started), made billions. Many argue that Apple has operated well under Tim Cook when Steve Jobs was unwell, which is true. But Mr. Jobs is a super sparkplug and makes others in the company sparkle too - and also the customers, who have made him into a cult leader. If and when Mr. Jobs were to leave again, you would have to ask: Would Apple's spark depart, too?
The answer won't be easy to find, and it won't be in the numbers. But if you were to own Apple stock at such a time, you would be well advised to do your utmost to figure out the answer ahead of time. Start getting close to Apple's "creatives" - its techies and designers - now.
Avner Mandelman is a director of Venator Capital Management and author of The Sleuth Investor.