Never Romanticize a Stock with Key Person Risk

Always invest in the company, never in the person.

Eyebrows were raised earlier this month when the Royal Bank of Canada published a late Friday press release saying:

“RBC was recently made aware of allegations involving [the Chief Financial Officer] and immediately launched an internal review and engaged outside legal counsel to investigate. The investigation found evidence that, in contravention of the RBC Code of Conduct, [the CFO] was in an undisclosed close personal relationship with another employee which led to preferential treatment of the employee including promotion and compensation increases. As a result, the two individuals have had their employment terminated.”

She’s not the first, nor will she be the last.

Office relationships happen more often than many expect. A study by PwC found in 2018 that 39% of forced CEO exits for that year were the result of “ethical lapses rather than financial performance or board struggles.”

Many present a public image that heavily contradicts their private behaviour. Who would have thought that John F. Kennedy led a private life so rife with infidelity? Or that baseball legend Mickey Mantle would consume all that alcohol before hitting a bunch of homeruns the next day? Did you know that Canada’s longest-serving Prime Minister, William Lyon Mackenzie King, would cancel cabinet meetings to attend seances with his dead dog?

These were public figures that historians write about, but don’t expect businesspeople to act any different.

We never invest in a company strictly because we like senior management or its CEO. Here today, gone tomorrow. Most of us are poor judges of character based on brief interactions, especially polished executives that are trained to persuade or talk in a certain way.

Instead, we buy companies with solid fundamental attributes, irrespective of the people on their payroll. Warren Buffett explains this better than us when he says, “I try to invest in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will.”

Speaking of Warren Buffett, the top three publicly traded companies with key person risk in our view are probably Berkshire Hathaway (Warren Buffett), Tesla (Elon Musk), and JPMorgan Chase (Jamie Dimon). All three of these stock prices would drop like a rock if their CEO stepped away from their current position.

When researching a new idea, we investigate the positives and the negatives about a company, spilling everything we can find onto one side of that ledger. At the end, we weigh the two sides and then make a decision. Before learning anything new about the company, if we know the name of its CEO before undertaking our research, we consider that to be a negative. She or he won’t be there forever, and a company that runs itself with minimal guidance from the board is the safest way to make our clients money.