Overconfidence About Irresistible Forces Can Bring Humbling Profit Drops

People love to shout, "We're Number One." It doesn't take much to trigger such a shout. We've all done it.

One of the primary causes of being overly independent is a sense of confidence that as a successful enterprise "our people" are better than anyone else's people. That feeling relates to a common psychological problem. Most people see themselves as superior to the vast mass of humanity in almost every area of activity. Carefully measure how the same person is doing, and you will find someone who normally operates around the average level.

Translated into an organizational setting, the individual weaknesses often become greater and the feeling of superiority stronger. A financial advisor was asked to look into a question of whether a company should emphasize dividends, acquisitions, or share repurchases as the primary way to grow stock price. The company had been doing plenty of each. The company became curious about the question after security analysts kept publishing reports showing that if the money spent in the past on acquisitions had gone for share repurchases, the company's earnings-per-share would have been much higher.

The results of the work showed that share repurchase had been clearly the way to go in the past, but this was true for the future only if earnings-per-share before the share repurchases were going to grow above a certain annual rate. Otherwise, faster dividend growth was the right approach.

Management could not imagine that its earnings-per-share would not expand rapidly (since it had done so for decades), so massive share repurchases were undertaken. Within a year, earnings-per-share dropped by a wide margin because of irresistible forces the company had been ignoring.

The company eventually surmounted the irresistible forces after several hard years. No sooner had these irresistible forces been overcome, when new ones arose which once again hurt earnings. Had the company waited to do the share repurchases until these troubled times, it could have bought back twice as many shares with the same amount of money.

Their mistake had been an unwillingness to have anyone question their future business success. The same financial advisor had pointed out several warning signals about these future problems that the company had ignored.

The lesson is you not only have to be willing to talk to others, you have to be willing to pay attention and act on what you hear as well. A favorite reaction by this company's senior management was to assert that "No one can understand our company from the outside -- we're too unique."

The financial advisor reports that many hundreds of companies have made similar claims in the past. If that's the case, then these companies may well have problems because of an inability to work with allies and outside resources. On the other hand, if it is not the case, then these firms have a severe case of the Independence Stall. Neither circumstance is desirable.

Are you running scared looking for potential problems or are you sure that no problems are on the horizon? The latter view can lead to plenty of real scares.