Reading people is the real competitive advantage

Before I switched to investing I used to be an engineer, so for a long while I had the engineer's bias for data: The more of it I had, the better investments I'd find. So I collected documents, numbers, graphs, filings, and created my own databases and also subscribed to commercial ones - all of which I browsed happily. It went well. But one day something happened that made me realize an important part of business couldn't be captured in text and numbers. This was when Steve Jobs recruited John Sculley to Apple.

Because then-small Apple was growing fast, Steve Jobs saw that he needed seasoned management. So he went straight to the top - John Sculley, president of PepsiCo, a Fortune 500 company - and tried to recruit him. At first Mr. Sculley scoffed, but Mr. Jobs was persistent; little by little Mr. Sculley wavered, but still wouldn't decide. Finally, Mr. Jobs asked him, disdainfully, "Do you want to spend the rest of your life selling sugared water or do you want a chance to change the world?" Within a day Mr. Sculley came over, and Silicon Valley was amazed: How did Mr. Jobs manage it?

It was then that I realized there'll always be a crucial part of business my databases will miss: The ability of the magician-in-chief (aka the CEO) to "walk boldly into men's hearts" (in Akira Kurosawa's words from his film Kagemusha) and rev them up.

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I recalled that in the good companies I followed, employees' hearts were usually revving and sparkling, while in the mediocre ones, they were idling and sputtering. The real engine of business, it seemed, was not just the human brain but also the human heart. Choosing the best brains may have been all the rage, but what about setting the attendant hearts aflame? If the first was science, the second was magic. So, by default, picking magic stocks was partly picking magicians.

Now, let's pause here, because you might rightly object that, as a value investor, if the price-to-book value, the price-to-earnings ratio, the enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortization), and the debt-to-equity ratio are all low, why should I waste time on how employees feel?

Simply because databases are open to every investor to see, and act on, so my competitive advantage using data alone is low; whereas if I can develop an eye for corporate magicians, I can get an extra edge in picking those who can light fires in people's hearts, which would generate even stronger numbers in the future.

How can such people-picking be learned? Two ways: First, try to meet as many truly gifted corporate leaders as you can - in annual meetings, in informal settings, in corporate gatherings - and study them. Not merely with your brain; try to develop a gut sense of their emotional impact. This way, when you do due diligence on fresh companies, look for those with a similar impact, on both others and on you.

But second, since the number of great leaders you can meet face-to-face is small, read also about great men and women of the past, so as to develop the same gut feeling of what made them different.

Why, before Harvard and Stanford ever used the case method, Plutarch's Parallel Lives (aka the "pasturage of great souls") was used in studying what was then called wisdom (the Greek term for management). Or read Thucydides's histories, or Xenophon's, or any of the other recorders of greatness, and study how past leaders solved problems and how they got others to follow them, then learn to identify both the opportunities and risks of great leadership.

Oh, yes, there are risks.

At the time Mr. Jobs got Mr. Sculley to join Apple, I chatted about it with a business school classmate, an ex-psychologist who used her people-reading ability to put together winning venture capital teams, and to advise Silicon Valley corporate boards. When I marvelled at Mr. Jobs's feat, she warned me that the way he prodded Mr. Scully into joining Apple also carried a future cost. Which cost? I asked. Well, said my classmate, Mr. Sculley just upturned his life to change Mr. Jobs's disdain into approval; but he must also resent it, though he may not know it yet. So in future he must strive to get even with Mr. Jobs. And when he does, sell the stock.

I laughed at this offbeat prediction. But indeed within a few years, Mr. Sculley deposed Mr. Jobs in a Shakespearean boardroom drama; Apple almost disintegrated, and the stock plunged precipitously. None of this was readable in the databases. Mr. Jobs was then called back - at which point employees' hearts revved again, and the company (and the stock) blossomed. This was not in the databases, either. I then understood that if I could ever read people like that, I could get a clear advantage - and so can you.

Thus, besides The Globe and Mail, The Wall Street Journal, annual and brokerage reports, and databases, you should also start reading the classics, take notes, then let your gut be your CEO-picking guide.