William N. Thorndike, Jr. - The Outsiders

You really only need to know three things to evaluate a CEO's greatness: the compound annual return to shareholders during his or her tenure and the return over the same period for peer companies and for the broader market (usually measured by the S&P 500).

The other important element in evaluating a CEO's track record is performance relative to peers, and the best way to assess this is by comparing a CEO with a broad universe of peers.

Capital allocation - the process of deciding how to deploy the firm's resources to earn the best possible return for shareholders.

CEOs need to two things well to be successful: run their operations efficiently and deploy the cash generated by those operations.

Basically, CEOs have five essential choices for deploying capital - investing in existing operations, acquiring other businesses, issuing dividends, paying down debt, or repurchasing stock - and three alternatives for raising it - tapping internal cash flow, issuing debt, or raising equity. Think of these options collectively as a tool kit. Over the long term, returns for shareholders will be determined largely by the decisions a CEO makes in choosing which tools to use (and which to avoid) among these various options. Stated simply, two companies with identical results and different approaches to allocating capital will derive two different long-term outcomes for shareholders.

Essentially, capital allocation is investment, and as a result all CEOs are both capital allocators and investors. In fact, this role just might be the most important responsibility any CEO has, and yet despite its importance, there are no courses on capital allocation at the top business schools.

As Warren Buffett has observed, very few CEOs come prepared for this critical task:

The heads of many companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration, or sometimes, institutional politics. Once they become CEOs, they now must make capital allocation decisions, a critical job that they may have never tacked and that is not easily mastered. To stretch the point, it's as if the final step for a highly talented musician was not to perform at Carnegie Hall, but instead, to be named Chairman of the Federal Reserve.

Singleton focused Teledyne's capital on selective acquisitions and a series of large share repurchases. He was restrained in issuing shares, made frequent use of debt, and did not pay a dividend until the late 1980s. In contrast, the other conglomerates pursued a mirror-image allocation strategy - actively issuing shares to buy companies, paying dividends, avoiding share repurchases, and generally using less debt. In short, they deployed a different set of tools with very different results.

They seemed to operate in a parallel universe, one defined by devotion to a shared set of principles, a worldview, which gave them citizenship in a tiny intellectual village. Call it Singletonville, a very select group of men and women who understood, among other things, that:

• Capital allocation is a CEO's most important job.
• What counts in the long run is the increase in per share value, not overall growth or size.
• Cash flow, not reported earnings, is what determines long-term value.
• Decentralized organizations release entreprenurial energy and keep both costs and "rancor" down.
• Independent thinking is essential to long-term success, and interactions with outside advisers (Wall Street, the press, etc.) can be distracting and time-consuming.
• Sometimes the best investment opportunity is your own stock.
• With acquistions, patience is a virtue... as is occasional boldness.

The residents of Singletonville, our outsider CEOs, also shared an interesting set of personal characteristics: They were generally frugal (often legendarily so) and humble, analytical, and understated. They were devoted to their families, often leaving the office early to attend school events. They did not typically relish the outward-facing part of the CEO role. They did not give chamber of commerce speeches, and they did not attend Davos. They rarely appeared on the covers of business publications and did not write books of management advice. They were not cheerleaders or marketers or backslappers, and they did not exclude charisma.

It is impossible to produce superior performance unless you do something different. - John Templeton

The New Yorker's Atul Gawande uses the term positive deviant to describe unusually effective performers in the field of medicine. To Gawande, it is natural that we should study these outliers in order to learn from them and improve performance.

All were first-time CEOs, most with very little prior management experience. Not once came to the job from a high-profile position, and all but one were new to their industries and companies. Only two had MBAs.

They were positive deviants, and they were deeply iconoclastic.

The word iconoclast is derived from Greek and means "smasher of icons." The word has evolved to have the more general meaning of someone who is determinedly different, proudly eccentric. The original iconoclasts came from outside the societies (and temples) where icons resided; they were challengers of societal norms and conventions, and they were much feared in ancient Greece.

The CEOs profiled in this book were not nearly so fearsome, but they did share interesting similarities with their ancient forbears: they were also outsiders, disdaining long-accepted conventional approaches (like paying dividends or avoiding share repurchases) and relishing their unorthodoxy.

Theirs was an intelligent iconoclasm informed by careful analysis and often expressed in unusual financial metrics that were distinctly different from industry or Wall Street conventions.

They came from a variety of backgrounds: one was an astronaut who had orbited the moon, one a widow with no prior business experience, one inherited the family business, two were highly quantitative PhDs, one an investor who'd never run a company before. They were all, however, new to the CEO role, and they shared a couple of important traits, including fresh eyes and a deep-seated commitment to rationality.

Isiah Berlin, in a famous essay about Leo Tolstoy, introduced the instructive contrast between the "fox," who knows many things, and the "hedgehog," who knows one thing but knows it very well. Most CEOs are hedgehogs - they grow up in an industry and by the time they are tapped for the top role, have come to know it thoroughly. They are many positive attribute associated with hedgehogness, including expertise, specialisation, and focus.

Foxes, however, also have many attractive qualities, including an ability to make connections across fields and to innovate, and the CEOs in this book were definite foxes. They had familiarity with other companies and industries and disciplines, and this ranginess translated into new perspectives, which in turn helped them to develop new approaches that eventually translated into exceptional results.

In the 1986 Berkshire Hathaway annual report, Warren Buffett looked back on his first twenty-five years as a CEO and concluded that the most important and surprising lessons from his career to date was the discovery of a mysterious force, the corporate equivalent of teenage peer pressure, that impelled CEOs to imitate the actions of their peers. He dubbed this powerful force the institutional imperative and noted that it was nearly ubiquitous warning that effective CEOs needed to find some way to tune it out.

The CEOs in this book all managed to avoid the insidious influence of this powerful imperative.

Each ran a highly decentralised organisation; made at least one veery large acquisition; developed unusual, cash flow - based metrics; and bought back a significant amount of stock. None paid meaningful dividends or provided Wall Street guidance.

At bottom, these CEOs thought more like investors than managers.

A distant mirror: 1974-1982: Post-World War II period looks most likely today's extended malaise: the brutal 1974-1982 period.

The times, like now, were so uncertain and scary that most managers sat on their hands, but for all the outsider CEOs it was among the most active periods of their careers - every sing one was engaged in either a significant share repurchase program or a series of large acquisitions (or in the case of Tom Murphy, both). As a group, they were, in the words of Warren Buffett, very "greedy" while their peers were deeply "fearful."

When they saw compelling discrepancies between value and price, they were prepared to act boldly. When their stock was cheap, they bought it (often in large quantities), and when it was expensive, they used it buy other companies or to raise inexpensive capital to fund future growth.

As a group, they were deeply independent, generally avoiding communication with Wall Street, disdaining the use of advisers, and preferring decentralised organizational structures that self-selected for other independent thinkers.

This freshness of perspective is an age-old catalyst for innovation across many field. In science, Thomas Kuhn, inventor of the concept of the paradigm shift, found that the greatest discoveries were almost invariably made by newcomers and the very young (think of the middle-aged former printer, Ben Franklin, taming lightning; or Einstein, the twenty-seven-year-old patent clerk, deriving E = mc2).

As a group, they were deeply independent, generally avoiding communication with Wall Street, disdaining the use of advisers, and preferring decentralised organisational structures that self-selected for other independent thinkers.

Gladwell's rule is a guide to achieving mastery*, which is not the necessarily the same thing as innovation. As John Templeton's quote at the beginning of this chapter suggests, exceptional relative performance demands new thinking, and at the center of the worldview shared by these CEOs was a commitment to rationality, to analysing the data, to thinking for themselves.

*Referring to outliers, rule of thumb for expertise in any field requires ten thousand hours of practice.

In all cases, this led the outsider CEOs to focus on cash flow and to forgo the blind pursuit of the Wall Street holy grail of reported earnings. Most public company CEOs focus on maximising quarterly reported net income, which is understandable since that is Wall Street's preferred metric.

Net income, however, is a bit of a blnt instrument and can be significantly distorted by differences in debt levels, taxes, capital expenditures, and past acquisition history.

As a result, the outsiders (who often had complicated balance sheets, active acquisition programs, and high debt levels) believed the key to long-term value creation was to optimize free cash flow, and this emphasis on cash informed all aspects of how they ran their companies - from the way they paid for acquisitions and managed their balance sheets to their account policies and compensation systems.

This single-minded cash focus was the foundation of their iconoclasm.

For Henry Singleton in the 1970s and 1980s, it was stock buybacks; for John Malone, its was the relentless pursuit of cable subscribers; for Bill Anders, it was divesting noncore businesses; for Warren Buffett, it was the generation and deployment of insurance float.

At the core of their shared worldview was the belief that the primary goal for any CEO was to optimize long-term value per share, not organizational growth. This may seem like an obvious objective; however, in American business, there is a deeply ingrained urge to get bigger. Larger companies get more attention in the press; the executives of those companies tend to earn higher salaries and are more likely to be asked to join prestigious boards and clubs. As a result, it is very rare to see a company proactively shrink itself. And yet virtually of these CEOs shrank their share bases significantly through repurchases. Most also shrank their operations through asset sales or spin-offs, and they were not shy about selling (or closing) underperforming divisions. Growth, it turns out, often doesn't correlate with maximizing shareholder value.

This pragmatic focus on cash and accompanying spirit of proud iconoclasm was exemplified by Henry Singleton, in a rare 1979 interview with Forbes magazine: "After we acquired a number of businesses, we reflected on business. Our conclusion was the key was cash flow . . . Our attitude toward cash generation and asset management came out of our own thinking." He added (as though he needed to), "It is not copied."

The formula that allowed Murphy to overtake Paley's QE2 was deceptively simple: focus on industries with attractive economic characteristics, selectively use leverage to buy occasional large properties, improve operations, pay down debt, and repeat. As Murphy put it succinctly in an interview with Forbes, "We just kept opportunistically buying assets, intelligently leveraging the company, improving operations and then we'd . . . take a bit of something else." What's interesting, however, is that his peers as other media companies didn't follow this path. Rather, they tended, like CBS, to follow fashion and diversify into unrelated businesses, build large corporate staffs, and overpay for marquee media properties.

Capital cities under Murphy was an extremely successful example of what we would now call a roll-up. In a typical roll-up, a company acquires a series of businesses, attempts to improve operations, and then keeps acquiring, benefiting over time from scale advantages and best management practices. This concept came into vogue in the mid- to late 1990s and flamed out in the early 2000s as many of the leading companies collapsed under the burden of too much debt. These companies typically failed because they acquired too rapidly and underestimated the difficulty and importance of integrating acquisitions and improving operations.

Murphy's approach to the roll-up was different. He moved slowly, developed real operational expertise, and focused on a small number of large acquisitions that he knew to be high-probability bets. Under Murphy, Capital Cities combined excellence in both operations and capital allocation to an unusual degree. As Murphy told me, "The business of business is a lot of little decisions every day mixed up with a few big decisions."

Murphy's first move was to elevate Burke to the role of president and chief operating officer.

Burke believed his "job was to create the free cash flow and Murphy's was to spend it."

During the extended bear market of the mid-1970s to early 1980s, Murphy became an aggressive purchaser of his own shares, eventually buying in close to 50 percent, most of it at single-digit price-to-earnings (P/E) multiples.

The core economic rationale for the deal was Murphy's conviction that he could improve the margins for ABC's TV stations from the low thirties up to Capital Cities' industry-leading levels (50-plus percent). Under Burke's oversight, the staff that oversaw ABC's TV station group dropped from sixty to eight, the head count at the flagship WABC station in New York was from six hundred to four hundred, and the margin gap was closed.

Burke and Murphy wasted little time in implementing Capital Cities' lean, decentralized approach - immediately cutting unnecessary perks, such has the executive elevator and the private dining room, and moving quickly and the private dining room, and moving quickly to eliminate redundant positions, laying off fifteen hundred employees in the first several months after the transaction closed. They also consolidated offices and sold unnecessary real estate, collecting $175 million for the headquarters building in midtown Manhattan.

The Nuts and Bolts

There are two basic types of resources that any CEO needs to allocate: financial and human.

"Decentralisation is the cornerstone of our philosophy. Our goal is to hire the best people we can and give them the responsibility and authority they need to perform their jobs. All decisions are made at the local level. . . . We expect our managers . . . to be forever cost conscious and to recognize and exploit sales potential."

The company's guiding human resource philosophy, repeated ad infinitum by Murphy, was to "hire the best people you can and leave them alone." As Burke told me, the company's extreme decentralized approach "kept both costs and rancor down."

Frugality was also central to the ethos. Murphy and Burke realized early on that while couldn't control your revenues at a TV station, you could control your costs. They believed the the best defense against the revenue lumpiness inherent in advertising-supported businesses was a constant vigilance on costs, which became deeply embedded in the company's culture.

Murphy and Burke believed that even the smallest operating decisions, particularly those relating to head count, could have unforeseen long-term costs and needed to be watched constantly.

Murphy and Burke realized that the key drivers of profitability in most of their businesses were revenue growth and advertising market share, and they were prepared to invest in their properties to ensure leadership in local markets.

In the area of capital allocation, Murphy's approach was highly differentiated from his peers. He eschewed diversification, paid de minimum dividends, rarely issued stock, made active use of leverage, regularly repurchased shares, and between long periods of inactivity, made the occasional very large acquisition.

The two primary sources of capital for Capital Cities were internal operating cash flow and debt. As we've seen, the company consistently high, industry-leading levels of operating cash flow, providing Murphy with a reliable source of capital to allocate to acquisitions, buybacks, debt repayment, and other investment options.

Murphy also frequently used debt to fund acquisitions, once summarizing his approach as "always, we've . . . taken the assets once we've paid them off and leveraged them again to buy other assets." After closing an acquisition, Murphy actively deployed free cash flow to reduce debt levels, and these loans were typically paid down ahead of schedule. The bulk of the ABC debt was retired within three years of the transaction.

Murphy and Burke actively avoided dilution from equity offerings.

To Murphy, as a capital allocator, the company's extreme decentralisation had important beliefs: it allowed the company to operate more profitably than its peers (Capital Cities had the highest margins in each of its business lines), which in turn gave the company an advantage in acquisitions by allowing Murphy to buy properties and know that under Burke, they would quickly be made more profitable, lowering the effective price paid. In other words, the company's operating and integration expertise occasionally gave Murphy that scarcest of business commodities: conviction. And when he had conviction, Murphy was prepared to act aggressively.

Murphy was willing to wait a long time for an attractive acquisition. He once said, "I get paid not just to make deals, but to make good deals." When he saw something that he liked, however, Murphy was prepared to make a very large bet, and much of the value created during his nearly thirty-year tenure as CEO was the result of a handful of large acquisition decisions, each of which produced excellent long-term returns. These acquisitions represented 25 percent or more of the company's market capitalisation at the time they were made.

Murphy has an unusual negotiating style. He believed in "leaving something on the table" for the seller and said that in the best transactions, everyone came away happy.

If he though their proposal was high, he would counter with his best price, and if the seller rejected his offer, Murphy would walk away. He believed this straightforward approach saves time and avoided unnecessary acrimony.

I change my mind when the facts change. What do you do? - John Maynard Keynes

For most of the twentieth century, public companies were expected to pay out a portion of their annual profits as dividends. Many investors, particularly senior citizens, relied on these dividends for income and looked closely at dividend levels and policies in making investment decisions.

Singleton was a very disciplined buyer, never paying more than twelve times earnings and purchasing most companies at significantly lower multiples. This compares to the high P/E multiple on Teledyne's stock, which ranged from a low of 20 to a high of 50 over this period.

Over its first ten years as a public company, Teledyne's earnings per share (EPS) grew an astonishing sixty-four-fold, while shares outstanding grew less than fourteen times, resulting in significant value creation for shareholders.

Singleton eschewed reported earnings, the key metric on Wall Street at the time, running his company instead to optimize cash flow.

As he once told Financial World magazine, "If anyone wants to follow Teledyne, they should get used to the fact that our quarterly earnings will jiggle. Our accounting is set to maximize cash flow, not reported earnings." Not a quote you're likely to hear the typical Wall Street - focused Fortune 500 CEO today.

Singleton and Roberts quickly improved margins and dramatically reduced working capital at Teledyne's operations, generating significant cash in the process. The results can be seen in the consistently high return on assets for Teledyne's operating businesses, which averaged north of 20 percent throughout the 1970s and 1980s.

Singleton began: "Arthur, I've been thinking about it and our stock is simply too cheap. I think we can earn a better return buying our shares at these levels than by doing almost anything else. I'd like to announce a tender - what do you think?" Rock reflected a moment and said, "I like it."

With those words, one of the seminal moments in the history of capital allocation was launched. Starting with that 1972 tender and continuing for the next twelve years, Singleton went on an unprecedented share repurchasing spree that had a galvanic effect on Teledyne's stock price while also almost single-handedly overturning long-held Wall Street beliefs.

Prior to the early 1970s, stock buybacks were uncommon and controversial. The conventional wisdom was that repurchases signaled a lack of internal investment opportunity, and they were regarded by Wall Street as a sign of weakness. Singleton ignored this orthodoxy, and between 1972 and 1984, in eight seperate tender offers, he bought back an astonishing 90 percent of Teledyne's outstanding shares. As Munger says, "No one have ever bought in shares as aggressively."

Singleton believed repurchases were a far more tax-efficient method for returning capital to shareholders than dividends, which for most of his tenure were taxed at very high rates. Singleton believed buying stock at attractive prices was self-catalysing, analogous to coiling a spring that at some further point would surge forward to realize full value, generating exceptional returns in the process. These repurchases provided a useful capital allocation benchmark, and whenever the return from purchasing his stock looked attractive relative to other investment opportunities, Singleton tendered for his shares.

Repurchases became popular in the 1990s and have frequently been used by CEOs in recent years to prop up sagging stock prices. Buybacks, however, add value for shareholders only if they are made at attractive prices. Not surprisingly, Singleton bought extremely well, generating an incredible 42 percent compound annual return for Teledyne's shareholders across the tenders.

In all, Singleton spent an incredible $2.5 billion on the buybacks.

From 1971 to 1984, Singleton bought back huge chunks of Teledyne's stock at low P/Es while revenues and net income continued to grow, resulting in an astonishing fortyfold increase in earnings per share.

In the mid-1970s, Singleton finally had an opportunity to act on this lifelong fascination when he assumed direct responsibility for investing the stock portfolios at Teledyne's insurance subsidiaries during a severe bear market with P/E ratios at their lowest levels since the Depression.

He invested over 70 percent of the combined equity portfolios in just five companies, with an incredible 25 percent to one company (his former employer, Litton industries). This extraordinary portfolio concentration (a typical mutual fund owns over one hundred stocks) caused consternation on Wall Street, where many observers thought Singleton was preparing for a new round of acquisitions.

Singleton has no such information, but it is instructive to look more closely at how he invested these portfolios. His top holdings were invariably companies he knew well, whose P/E ratios were at or near record lows at the time of his investment. As Charlie Munger said of Singleton's investment approach, "Like Warren and me, he was comfortable with concentration and bought only a few things that he understood well."

The Nuts and Bolts

Teledyne's board consisted of only six directors, including Singleton, half of them insiders. It was an exceptionally talented group, however, and each member had a significant economic interest in the company. In addition to Singleton, Roberts, and Kozmetzky, board members included Claude Shannon, Singleton's MIT classmate and the father of information theory; Arthur Rock, the legendary venture capitalist; and Fayez Sarofim, the billionaire Houston-based fund manager. This group collectively owned almost 40 percent of the company's stock by the end of the period.

Fundamentally, there are two basic approaches to buying back stock. In the most common contemporary approach, a company authorizes an amount of capital (usually a relatively small percentage of the excess cash on its balance sheet) for the repurchase of shares and then gradually over a period of quarters (or sometimes years) buys in stock on the open market. This approach is careful, conservative, and, not coincidentally, unlikely to have any meaningful impact on long-term share values. Let's call this cautious, methodical approach the "straw."

The other approach, the one favored by the CEOs in this book and pioneered by Singleton, is quite a bit bolder. This approach features less frequent and much larger repurchases timed to coincide with low stock price - typically made within very short periods of time, often via tender offers, and occasionally funded with debt. Singleton, who employed this approach no fewer than eight times, disdained the "straw," preferring instead a "suction hose."

Singleton's 1980 share buyback provides an excellent example of his capital allocation acumen. In May of that year, with Teledyne's P/E multiple near an all-time low, Singleton initiated the company's largest tender yet, which was oversubscribed by threefold. Singleton decided to buy all the tendered shares (over 20 percent of shares outstanding), and given the company's strong free cash flow and a recent drop in interest rates, financed the entire repurchase with fixed-rate debt.

Buffett and Singleton: Separated at Birth?

Investment philosophy. Both Buffett and Singleton focused their investments in industries they knew well, and were comfortable with concentrated portfolios of public securities.

Dividends. Teledyne, along among conglomerates, didn't pay a dividend for its first twenty-six years. Berkshire has never paid a dividend.

Stock splits. Teledyne was the highest-priced issue on the NYSE for much of the 1970s and 1980s. Buffett has never split Berkshire's A shares (which now trade at over $120,000 a share).

Significant CEO ownership. Both Singleton and Buffett had significant ownership stakes in their companies (13 percent for Singleton and 30-plus percent for Buffett). They thought like owners because they were owners.

When a new CEO took over in January 1991, General Dynamics had $600 million of debt and negative cash flow, and faced conjecture about a possible bankruptcy. The company had revenues of $10 billion and a market capitalization of just $1 billion. In the words of Goldman Sach's defense analyst Judy Bollinger, the company was the "lowest of the low," the worst-positioned company in a declining industry.

In other words, this was a turnaround. Companies in financial distress often hire restructuring "consultants" who helicopter in, slash costs, negotiate with lenders and suppliers, and look to sell the company as quickly as possible before moving on to the next assignment. These hired guns tend to ignore longer-term considerations like culture, capital investment, and organizational structure, focused instead on short-term cash needs.

Turnarounds often succeed in generating attractive near-term returns, usually concluding with the sale of the business to a larger company, a process that has been likened to taking the last puffs from a cigar butt.

It is unusual for a turnaround to sustain high returns over long periods of time and across multiple CEOs, which is exactly what happened at General Dynamics.

This strategy rested on three key tenets:

1. Anders, borrowing a page from his former GE colleague Welch, believed General Dynamics should only be in businesses where it had the number one or number two market position.
2. The company would exit commodity businesses where returns were unacceptably low.
3. It would stick to businesses it knew well. Specifically, it would be wary of commercial businesses - long an elusive, holy grail-like source of new profits for defense companies.

The company would exit businesses that did not meet these strategic criteria.

Let's start with cash generation. When Anders and Mellor began to implement their plan, General Dynamics was overleveraged and had negative cash flow. Over the ensuing three years, the company would generate $5 billion of cash. There were two basic sources of this astonishing influx: a remarkable tightening of operations and the sales of businesses deemed noncore by Ander's strategic framework.

In the first two years of their regime, Anders and Mellor reduced overall head count by nearly 60 percent (and corporate staff by 80 percent), relocated corporate headquarters from St. Louis to northern Virginia, instituted a formal capital approval process, and dramatically reduced investment in working capital.

These moves produced a tsunami of cash - a remarkable $2.5 billion - and the company quickly became the unquestioned leader among its peers in return on assets, a position it holds to this day.

Which brings us to the other larger-than-expected source of cash at the company: asset sales.

The result was a dramatic shrinking of the company through a series of highly accretive divestitures.

This was a first for the company and for the industry. In the first two years, after taking the reins as CEO, Anders sold the majority of General Dynamic's businesses, including its IT division, the Cessna aircraft business, and the missiles and electronics businesses.

As the cash from asset sales and improved operations poured in, Anders shifted his focus to capital allocation. With prices high, he chose not to make additional acquistions. Instead, he decided to return the majority of the company's cash to shareholders.

As the cash built up at General Dynamics, he developed two creative ideas for returning the majority of it to shareholders in an extraordinary tax-efficient manner.

First, Kapnick initiated a series of three special dividends to shareholders totaling just under 50 percent of the company's equity value.

As a next step, Anders and Kapnick announced a gigantic $1 billion tender to repurchase 30 percent of the company's shares (as we've seen, share repurchases are highly tax efficient versus traditional dividends, which are taxed at both the corporate and the individual levels).

As CEO after Ander's departure, Mellor continued to focus on optimizing operations and selling the last small noncore divisions, including the space systems unit. In 1995, however, he went on the offensive with the $400 million acquisition of Bath Iron Works, one of the largest domestic builders of navy ships. This acquisition had enormous symbolic value, signalling to employees and the Pentagon that the company was now ready to grow again. As Mellor said, "That Bath acquisition put an end to rumors the company would be completely liquidated."

The Nuts and Bolts

In the ares of operations, Anders and his successors focused on two primary priorities: decentralising the organization and aligning management compensation with shareholders' interests.

In the early 1990s, as they tightened operations and dramatically reduced headquarters staff, Anders and Mellor began to actively promote decentralization and push responsibility further down into the organization, eliminating layers of middle management.

Starting with Anders, the company also began to emphasize performance-based compensation.

He would have preferred a traditional stock option program but was told by the board that shareholders, disgruntled by the stock's weak performance in the years prior to his arrival, would not approve one.

The company, however, remained committed to performance-based compensation, and today bonus payments and option grants remain key components of executive pay at General Dynamics.

The company Malone decided to join had a long history of aggressive growth and would soon be flirting with bankruptcy.

Magness was particularly quick to grasp the industry's favorable tax characteristics.

Prudent cable operators could successfully shelter their cash flow from taxes by using debt to build new systems and by aggressively depreciating the costs of construction. These substantial depreciation charges reduced taxable income as did the interest expense on the debt, with the result that well-run cable companies rarely showed net income, and and as a result, rarely paid taxes, despite very healthy cash flows. If an operator then used debt to buy or build additional systems and depreciated the newly acquired assets, he could continue to shelter his cash flow indefinitely. Magness was among the first to full recognize these attributes and made aggressive use of leverage to build his company, famously saying it was "better to pay interest than taxes."

Malone had been dealt a tough hand, and he and Magness spent the next several years keeping the lenders at bay and the company out of bankruptcy. They met constantly with bankers. At one point in a particularly tenser lender meeting, Malone threw his keys on the conference room table and walked out of the room, saying, "If you want the systems, they're yours." The panicked bankers eventually relented and agreed to amend the terms on TCI's loans.

During this period, Malone introduced a new financial and operating discipline to the company, telling his managers that if they could grow subscribers by 10 percent per year while maintaining margins, he would ensure that they stayed independent.

The Edifice Complex

There is an apparent inverse correlation between the construction of elaborate new headquarters building and investor returns. As an example, over the last ten years, three media companies - The New York Times Company, IAC, and Time Warner - have all constructed elaborate, Taj Mahal - like headquarters towers in midtown Manhattan at great expense. Over that period, none of these companies has made significant share repurchases or had market-beating returns. In contrast, not one of the outsider CEOs built lavish headquarters.

In paging through analyst reports from early in the company's history, one can see a consistent recurring pattern of slightly higher-than-projected cash flow and subscriber numbers quarter after quarter.

By 1977, TCI had finally grown to the point that is was able to entice a consortium of insurance companies to replace the banks with lower-cost debt.

Malone, the engineer and optimizer, realized early on that the key to creating value in the cable television business was to maximize both financial leverage and leverage with suppliers, particularly programmers, and that the key to both kinds of leverage was size.

Malone's realisation that maximizing earnings per share (EPS), the holy grail for most public companies at that time, was inconsistent with the pursuit of scale in the nascent cable television industry. To Malone, higher net income meant higher taxes, and he believed that the best strategy for a cable company was to use all available tools to minimize reported earnings and taxes, and fund internal growth and acquisitions with pretax cash flow.

It's hard to overstate the unconventionality of this approach. At the time, Wall Street evaluated companies on EPS. Period. For a long time, Malone was alone in this approach within the cable industry; other large cable companies initially ran their companies for EPS, only later switching over to a cash flow focus once they realized the difficulty of showing EPS while growing a cable business. As longtime cable analyst Dennis Leibowitz told me, "Ignoring EPS gave TCI an important early competitive advantage versus other public companies."

While this strategy now seems obvious and was eventually copied by Malone's public peers, at the time, Wall Street did not know what to make of it. In lieu of EPS, Malone emphasized cash flow to lenders and investors, and in the process, invented a new vocabulary, one that today's managers and investors take for granted. Terms and concepts such as EBITDA (earnings before interest, taxes, depreciation, and amortisation) were first introduced into a business lexicon by Malone. EBITDA in particular was a radically new concept, going further up the income statement than anyone had gone before to arrive at a pure definition of the cash-generating ability of business before interest payments, taxes, and depreciation or amortisation charges. Today EBITDA is used throughout the business world, particularly in the private equity and investment banking industries.

The market for cable stocks remained volatile throughout the 1970s and into the early 1980s. Malone and Magness, concerned about the potential for a hostile takeover, took advantage of occasional market downturns to opportunistically repurchase stock, thereby increasing their combined stake.

From this point forward, with control and a healthier balance sheet, Malone focused on achieving scale with a unique combination of relentlessness and creativity. Using the debt available from the company's new lenders, internal cash flow, and the occasional equity offering, Malone began an extraordinary active acquisition program. Between 1973 and 1989, the company closed 482 acquisitions, an average of one every other week. To Malone, a subscriber was a subscriber.

The financial terms - twelve times EBITDA, $2,600 per subscriber - were extraordinary.

The Nuts and Bolts

As Malone sought to achieve scale by growing his subscriber base, three principles sources of capital were available to him in addition to TCI's robust operating cash flow: debt, equity, and asset sales. His use of each of these sources was distinctive.

He believed financial leverage had two important attributes: it magnified financial returns, and it helped shelter TCI's cash flow from taxes through the deductibility interest payments. Malone targeted a ratio of five times debt to EBITDA and maintained it throughout most of the 1980s and 1990s. Scale allowed TCI to minimize its cost of debt.

When it came to issuing equity, Malone was parsimonious, with the company's occasional offerings timed to coincide with record high multiples on his stock. As Malone said in a 1980 interview, "Our recent rise in stock price provided us with a good opportunity for this offering." He was justifiably proud of his stinginess in issuing equity and believed it was another factor that distinguished him from his peers.

Malone occasionally and opportunistically sold assets.

Malone carefully managed the company's supply of net operating losses (NOLs), accumulated over years of depreciation and interest deductions, which allowed him to sell assets without paying taxes. As a result of this tax shield, he was comfortable selling systems if prices were attractive, to raise capital to und future growth.

Another key source of capital at the company was taxes not paid.

As the company grew its cash flow by twentyfold over Malone's tenure, it never paid significant taxes. In fact, Malone's one extravagance in terms of corporate staff was in-house tax experts. The internal tax team met monthly to determine optimal tax strategies, with meetings chaired by Malone himself. When he sold assets, he almost sold for stock or sheltered gains through accumulated NOLs, and he made constant use of the latest tax strategies. As Dennis Leibowitz said, "TCI hardly ever disposed of an asset unless there was a tax angle to it."

He never paid dividends (or even considered them) and rarely paid down debt. He was parsimonious with capital expenditures, aggressive in regard to acquisitions, and opportunistic with stock repurchases.

To him, the math was undeniably clear: if capital expenditures were lower, cash flow would be higher.

He was also, however a value buyer, and he quickly developed a simple rule that became the cornerstone of the company's acquisition program: only purchase companies if the price translated into a maximum multiple of five times cash flow after the easily quantifiable benefits from programming discounts and overhead elimination had been realized.

Immediately after TCI took over the floundering Pittsburgh franchise from Warner Communications, it reduced payroll by half, closed the elaborate studios the prior owners had built for the city, and moved headquarters from a downtown skyscraper to a tire warehouse. Within months, the formerly unprofitable system was generating significant cash flow.

(As David Wargo said, "To understand the company you had to read all of their footnotes and very few did."

Every element of the company's strategy - from the pursuit of scale to tax minimization to the active use of financial leverage - was designed to optimize shareholder returns.

Establishing and maintaining an unconventional (approach) requires . . . frequently appearing downright imprudent in the eyes of conventional wisdom. - David Swensen, Chief Investment Officer, Yale University Endowment

It was at this time, coached by Buffett, that Graham made another unconventional decision and began aggressively buying her own stock, something very few people were even thinking about at the time. Over the next sever years, she would repurchase almost 40 percent of the company's shares at rock-bottom prices. Significantly, none of her peers at other major newspaper companies followed her lead.

The Nuts and Bolts

Her approach in this important area was characterized by industry-low level of dividends and debt, an industry-high level of stock repurchases, relatively few acquisitions, and a careful approach to capital expenditures.

During Graham's tenure, the Post Company generated consistently strong cash flow, with profitability improving dramatically during the decade of the 1980s as newspaper revenue spiked after the Star unfolded, and Dick Simmons increased margins across al the operating units.

Graham raised significant debt only a few times during her tenure, most notably to finance the 1986 purchase of the Capital Cities cable systems. The Post's strong cash flow, however, allowed the bulk of this debt load to be paid down in less than three years.

Throughout her tenure, she maintained a minimal level of dividends, believing them to be tax efficient.

The post, under Graham, consistently paid the lowest level of dividends among its peer group and thus had the highest retained earnings.

Graham would add enormous value for her shareholder by buying in a massive amount of stock (almost 40 percent eventually), most of it purchased during the 1970s and early 1980s at single-digit P/E multiples.

Ironically, in the early 1980s, the management consulting firm McKinsey advised the company to halt its buyback program. Graham followed McKinsey's advice for a little over two years, before, with Buffett's help, coming to her senses and resuming the repurchase program in 1984. Donald Graham reckons this high-priced McKinsey wisdom cost Post Shareholders hundreds of millions of dollars of value, calling it the "most expensive consulting assignment ever!"

Postscript: A Tale of Two Companies

Again, CEOs can only pay the hands they are dealt, and Donald Graham, as the CEO of a large newspaper company, was dealt tough cards (although thanks to his mother's diversification efforts, significantly better ones than his peers'). He has, however, played them substantially better than his peers by adhering to the tenets of his mother's approach: making selected acquisitions, aggressively and opportunistically repurchasing stock (including 20 percent of shares outstanding between 2009 and 2011), and keeping dividends levels relatively low.

In contrast, over the same period, the other well-known, publicly traded, family-owned Northeastern newspaper company - the Sulzbergers' New York Times Company - overpaid for an Internet portal (Ask.com), built an elaborate new corporate headquarters building in midtown Manhattan . . . and lost almost 90 percent of its value.

Stiritz had an unusual educational background for a CEO. He had an interrupted undergraduate experience, attending the University of Arkansas for only a year before leaving for a four-year stint in the navy when his funds ran out. During his years in the navy, he hones the poker skills that would eventually pay for this college tuition. After the navy, he retuned to college, completing his degree at Northwestern, where he majored in business studies. He never earned an MBA.

During his tenure, the business grew dramatically, with operating profits increasing fiftyfold through a relentless program of new product introductions and line extensions.

He immediately began to the remove underpinnings of his predecessors's strategy, and his first moves involved actively divesting businesses that did not meet his criteria for profitability and returns.

In his early years at the helm, Stiritz sold the Jack in the Box chain of fast-food restaurants, the mushroom farms, and the St. Louis Blues hockey franchise.

Stiritz proceeded to sell other noncore businesses, including the company's soybean operations and miscellaneous restaurant and food service operations, leaving Ralston as a pure branded products company.

Starting in the early 1980s, Stiritz overcame initial board resistance and intiated an aggressive stock repurchase program.

Starting in the mid-1980s, after the initial round of divestitures, Stiritz made two large acquisitions totalling a combined 30 percent of Ralston's enterprise value, both of them largely financed with debt.

Under Ralston's management, distribution was expanded, redundant costs were eliminated, new products were introduced, and cash flow grew significantly, creating significant value for shareholders.

By the late 1980s, the percentage of Ralston's revenues coming from consumer packaged goods had risen to almost 90 percent.

As the business mix at Ralston shifted toward branded products, pretax profit margins grew from 9 percent to 15 percent, and return on equity more than doubled, from 15 percent to 37 percent. When combined with a shrinking share purchase base, this produced exceptional growth in earnings per share and returns to shareholders.

Throughout the balance of the 1980s, Stiritz continued to optimize his portfolio of brands, making selected divestitures and add-on acquisitions. Business that could not generate acceptable returns were sold (or closed). These divestitures included underperforming food brands (including the Van de Kamp's frozen seafood division, a rare acquisition mistake) and the company's legacy agricultural feed business, Purina Mills, which had become a commodity business with chronic low returns and limited growth prospects. His add-on acquisitions focused on the core battery and pet food brands, particularly in underpenetrated international markets.

Throughout the 1990s, Stiritz focused on continued opportunistic stock buybacks, occasional acquisitions, and, significantly, the use of a relatively new structuring device, the spin-off, to rationalise Ralston's brand portfolio. Stiritz came to believe that even with a relatively decentralized corporate structure, some of the company's businesses were not receiving the attention deserved either internally or from Wall Street. To rectify this and to minimize taxes, Stiritz became an early user of spin-offs.

In a spin-off, a business unit is transferred from the parent company into anew corporate entity. Shareholders in the parent company are given equivalent pro rata ownership in the new company and can make their own decisions about whether to hold or sell these shares. Importantly, spin-offs highlight the value of smaller business units, allow for better alignment of management incentives, and, critically, defer capital gains taxes.

The Nuts and Bolts

Mauboussin told me, "Effective capital allocation . . . requires a certain temperament. To be successful you have to think like an investor, dispassionately and probabilistically, with a certain coolness. Stiritz had that mindset."

Stiritz himself likened capital allocation to poker, in which the key skills were an ability to calculate odds, read personalities, and make large bets when the odds were overwhelmingly in your favor. He was an active acquirer who was also comfortable selling or spinning off businesses that he felt were mature or underappreciated by Wall Street.

As longtime Goldman Sachs analyst Nomi Ghez emphasized to me, the food business had traditionally been a very profitable, predictable business generally characterized by low growth.

In fact, he fundamentally changed the paradigm by actively deploying leverage to achieve substantially higher returns on equity, pruning less profitable businesses, acquiring related businesses, and actively repurchasing shares.

The primary sources of funds at Ralston during Stiritz's tenure were internal cash flow, debt, and, particularly in the early years, proceeds from asset sales.

Operating cash flow was a significant and growing source of funds throughout Stiritz's time at the helm. Margins steadily improved under his management, reflecting both a shifting mix toward branded products and a leaner, more decentralized operating philosophy. By the time of the Nestlè sale, Ralston's margins were the highest in the packaged goods industry.

Stiritz, however, saw that the prudent use of leverage could enhance shareholders' returns significantly. He believed that businesses with predictable cash flows should employ debt to enhance shareholder returns, and he made active use of leverage to finance stock repurchases and acquisitions, including his two largest, Energizer and Continental. Ralston consistently maintained an industry-high average debt-to-cash-flow ratio during his tenure.

He started by selling noncore businesses, like the mushroom farms and the hockey team, that did not meet his criteria for profitability and returns, and these asset sales were an important early sources of cash for the company.

Outside of the steady, year-in, year-out patten of debt service, internal capital expenditures, and (minimal) dividends, Stiritz's two primary uses of cash were share repurchases and acquisitions.

He would eventually repurchase a phenomenal 60 percent of Ralston's shares, second only to Henry Singleton among the CEOs in this book, and he would earn very attractive returns on these buybacks, averaging a long-term internal rate of return of 13 percent.

He was, however, a very frugal buyer, preferring opportunistic open-market purchases to largest tenders that might raise the stock price prematurely. These purchases were consistently made when P/E multiples were at cyclical low points.

Stiritz focused on sourcing acquisitions through direct contact with sellers, avoiding competitive auctions whenever possible. The Continental Baking acquisition was sourced from a letter he sent directly to ITT chairman Rand Araskog, thus circumventing an auction.

He focused on newfangled metrics, like EBITDA and internal rate of return (IRR), that were becoming the lingua franca of the nascent private equity industry, and he eschewed more traditional accounting measures, such as reported earnings and book value, that were Wall Street's preferred financial metrics at the time. He had particular disdain for book value, once declaring during a rare appearance at an industry conference that "book equity has no meaning in our business."

He was well known for showing up alone to important due diligence meetings or negotiations where the other side of the table was crowded with bankers and lawyers.

He was always a fox-like sponge for new thinking regardless of its origin. John McMillin, a longtime industry analyst, once wrote, "Some people are innovators and some people borrow ideas from others. Stiritz is both (and that's meant as a compliment)."

By the mid-to late 1990s, Stiritz's heresy had become orthodoxy, and virtually all his peers had implemented different versions of his strategy: divesting noncore assets, repurchasing shares, and acquiring businesses complementary to their core product lines.

A Recent Example: Sara Lee

The latest, and maybe last, of the consumer products companies to follow in Stiritz's footsteps is Sara Lee, which over the last five years, under the leadership of CEOs Brenda Barnes and Marcel Smits, has sold off noncore operations, bought back 13 percent of its shares, maintained a relatively high level of leverage, and generated returns for shareholders that have dwarfed its peer group.

It's remarkable how much value can be created by a small group of really talented people. - David Wargo, Putnam Investments

Nuts And Bolts

Compensation for top executives was, in Smith's words, "competitive but not extraordinary." However, the company did offer equity to key managers through options and a generous stock purchase program in which the company matched employee investments up to a stated maximum level. The net effect of these initiatives, according to Woody Ives, was that the executive team "felt like owners . . . we were all shareholders and behaved as such."

The three primary sources of cash during Smith's long tenure were operating cash flow, long-term debt, and proceeds from occasional large asset sale.

The movie theater business is characterised by exceptional cash flow characteristics due to its negative working capital needs (customers pay in advance, while the movie studios are paid ninety days in arrears for their films and low capital requirements (once a theater is built, very little investment is required to maintain it).

He focused on maximizing cash flow, not traditional earnings per share (EPS)

When I first met with Smith in his office, he showed me the 1962 annual report, his first as CEO, in which he refers repeatedly to cash earnings (defined as net earnings plus depreciation) as the key metric in evaluating company performance, not net income.

As longtime General Cinema CFO Woody Ives said, "Our focus was always on cash," and across Smith's tenure, the company consistently generated high levels of operating cash flow.

Smith disdained equity offerings. "We never issued any stock. I was like a feudal lord, holding onto the ancestral land!"

The company did, however, make strategic use of debt to fund acquisitions. Its two largest purchases, Carter Hawley Hale and Harcourt Brace Jovanovich, were entirely debt financed. As a result, from the mid-1980s on, the company consistently maintained debt-to-cash flow ratios of at least three times, leveraging equity returns and helping minimize taxes.

Smith deployed the cash provided by these various sources into three principal outlets: acquisitions, stock repurchases, and capital expenditures. The company paid minimal dividends and was notable for its willingness to hold large cash balances while waiting for attractive investment opportunities to emerge.

Smith's acquisitions shared several common characteristics. They were market leaders with solid growth prospects and respected brand names.

Smith was a steady repurchaser of General Cinema's stock over time, eventually buying back one-third of the company's shares.

The most powerful force in the universe is compound interest. - Albert Einstein

Being a CEO has made me a better investor, and vice versa. - Warren Buffett

Buffett has been attracted to Berkshire by its cheap price relative to book value. At the time, the company has only a weak market position in a brutally competitive commodity business (suit linings) and a mere $18 million in market capitilzation.

Margin of safety, Graham's term for a piece well below intrinsic value (the price a fully informed, sophisticated buyer would pay for the company).

The lion's share of this capital was used to acquire National Indemnity, a niche insurance company that generated prodigious amounts of cash in the form of float, premium income generated in advance of losses and expense. Buffett invested this float very effectively, buying both publicly traded securities and wholly owned businesses, including the Omaha Sun, a weekly newspaper in Omaha, and a bank in Rockford, Illinois.

Fear of inflation was a constant theme in Berkshire's annual report throughout the 1970s and into the early 1980s. The conventional wisdom at the time was that hard assets (gold, timber, and the like) were the most effective inflation hedges. Buffett, however, under Munger's influence and in a shift from Graham's traditional approach, had come to a different conclusion. His contrarian insight was that companies with low capital needs and the ability to raise prices were actually best positioned to resist inflation's corrosive effects.

This led him to invest in consumer brands and media properties - businesses with "franchises," dominant market positions, or brand names. Along with this shift in investment criteria came an important shift to longer holding periods, which allowed for long-term pretax compounding of investment values.

See's : The Turning Point

At the time, the company had $7 million in tangible book value and $4.2 million in pretax profits, so they were paying a seemingly exorbitant multiple of over three times book value (but only six times pretax income). See's was expensive by Graham's standards, and he would never have touched it. Buffett and Munger, however, saw a beloved brand with excellent returns on capital and untapped pricing power, and they immediately installed a new CEO, Chuck Huggins, to take advantage of this opportunity.

See's has experienced relatively little unit growth since it was acquired, but due to the power of its brand, it has been able to consistently raise prices, resulting in an extraordinary 32 percent compound return on Berkshire's investment over its first twenty-seven years.

In the late 1990s and early 2000s, Buffett was an opportunistic buyer of private companies, many of them in industries out of favor after the September 11 terrorist attacks.

The Nuts and Bolts

Remarkably, Buffett has almost entirely eschewed debt and equity issuances - virtually all of Berkshire's investment capital has been generated internally.

The company's primary source of capital has been float from its insurance subsidiaries, although very significant cash has also been provided by wholly owned subsidiaries and by the occasional sale of investments. Buffett has in effect created a capital "flywheel" at Berkshire, with funds from these sources being used to acquire full or partial interests in other cash-generating businesses whose earnings in turn fund other investments, and so on.

Insurance is Berkshire's most important business by a wide margin and the critical foundation of its extraordinary growth.

"Float is money we hold but don't own. In an insurance operation, float arises because premiums are received before losses are paid, and interval that sometimes extends over many years. During that time, the insurer invests the money." This is another example of a powerful iconoclastic metric, one that the rest of the industry ignored at the time.

Buffett believes they to long-term success is "temperament," a willingness to be "fearful when others are greedy and greedy when they are fearful."

Buffett's approach to capital allocation was unique: he never paid a dividend or repurchased significant amounts of stock. Instead, with Berkshire's companies typically requiring little capital investment, he focused on investing in publicly traded stocks and acquiring private companies, options not available to most CEOs who lacked his extensive investment experience.

Portfolio management - how many stocks an investor owns and how long he holds them - has an enormous impact on returns. Two investors with the same investment philosophy but different approaches to portfolio management will produce dramatically different results. Buffett's approach to managing Berkshire's stock investments has been distinguished by two primary characteristics: a high degree of concentration and extremely long holding periods. In each of these areas, his thinking is unconventional.

Buffett believes that exceptional returns come from concentrated portfolios, that excellent investment ideas are rare, and he has repeatedly told students that their investing results would improve if at the beginning of their careers, they were handed a twenty-hole punch card representing the total number of investments they could make in their investing lifetimes. As he summarized in the 1993 annual report, "We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort level he must feel with its economic characteristics before buying into it."

The top five positions in Berkshire's portfolio have typically accounted for a remarkable 60-80 percent of total value. This compares with 10-20 percent for the typical mutual fund portfolio.

He had held his current top five stock positions for over twenty years on average. This compares with an average holding period of less than one year for the typical mutual fund.

Two Interesting Patterns

For those interested in a deeper dive into Buffett's stock market investing, two other patterns are worthy of notice.

The first is deep-rooted contrarianism. Buffett has frequently cited Benjamin Graham's "Mr Market" analogy, in which "an obligating fellow named 'Mr. Market' shows up every day to either buy from you or sell to you . . . the more manic-depressive this chap is, the greater the opportunities available to the investor." Buffett systematically buys when Graham's Mr. Market is feeling most blue. The majority of Berkshire's major public market investments originated in some sort of industry or company crisis that obscured the value of a strong underlying business.

The second pattern is timing investments to coincide with significant management or strategy changes.

When, however, Buffett sees that a new management team is removing the amateurs from the foursome and returning focus to the company's core businesses, he pays close attention.

In his 1986 Berkshire annual report, Buffett described the discovery of the surprisingly powerful institutional imperative, which led managers to mindlessly imitate their peers.

Buffett spends his time differently than other Fortune 500 CEOs, managing his schedule to avoid unnecessary distractions and preserving uninterrupted time to read (five newspapers daily and countless annual reports) and think.

Buffett and Sarbanes-Oxley

Buffett believes that best boards are composes of relatively small groups (Berkshire has twelve directors) of experienced businesspeople with large ownership stakes. (He requires that all directors have significant personal capital invested in Berkshire's stock.) He believes directors should have exposure to the consequences of poor decisions (Berkshire does not carry insurance for its directors) and should not be reliant on the income from board fees, which are minimal at Berkshire.

You are right not because others agree with you, but because your facts and reasoning are sound. - Benjamin Graham

What makes him a leader is precisely that he is able to think things through for himself. - William Deresiewicz, lecture to the West Point plebe class, October 2009

A virtually identical blueprint: they discipline (occasionally large) acquisitions, used leverage selectively, bought back a lot of stock, minimized taxes, ran decentralized organizations, and focused on cash flow over reported net income.

Although the outsider CEOs were an extraordinarily talented group, their advantage relative to their peers was one of temperament, not intellect.

Particularly during times of crisis, the natural, instinctive reaction is to engage in what behaviorists call social proof and do what your peers are doing. In today's world of social media, instant messaging, and cacophonous cable shows, it's increasingly hard to cut through the noise, to step back and engage Kahneman's system 2, which is where a tool that's been much in the news lately can come in handy.