The first important implication from this analysis is that companies that have had strong stock-price performance in recent years cannot even think of resting on their laurels expecting the next few years will be more of the same. Going forward, they are just as likely to be a top performer as a bottom performer.
From the analysis of the S&P 500, this of course is a statistical reality but it is also an important cultural point. Just when strong- performing organizations become impressed by their own success, the problems seem to start. The CFO should make sure the management team realizes success is frail and to be successful the team must remain humble and hungry.
In fairness, it can be difficult to keep positive momentum when managers become satisfied with their success. But one proven technique to keep improvements rolling when a company leads an industry is to stop benchmarking against others and begin benchmarking against your own company.
If you are the best, beat yourself. It’s about continuous improvement. You must never be content. That’s how great athletes become better. They aim to beat themselves.
The second important implication from this analysis concerns business unit portfolio management. Don’t assume the successful business units over the last few years will necessarily be the best sources of value creation going forward. They may or they may not.
Many management teams make the mistake of over-investing in what has been successful rather than what will be successful. This can be treacherous.
To be sure, to have a vision for the future you must first understand the past. Where have you been successful and why? Where have you delivered strong growth while realizing high returns on capital? How sustainable are these drivers of this success?
To assess the sustainability of success into the future requires a thorough assessment of sources of differentiation and their durability. When you are successful you attract competition, so a rigorous assessment of sustainability must include an in-depth assessment of each competitor and its ability to catch up and pass us by. Are there industry changes that will affect the ability to perform? Will your company lead these changes?
Similarly, where you have been less successful, are there reasons to believe the future may be brighter? This is perhaps the slipperiest of slopes. When we know a business well and the people running it, we often want to believe they can turn it around but often they cannot.
It is difficult to be objective but every effort is required to be as objective as possible when predicting a turnaround of a poor-performing business. Remember, the business is just as likely to continue to lag as it is to improve.
The science of economics and the theory of modern corporate finance, for example, were both established on a foundation of rational human behavior, but cognitive biases keep most of us from being as rational as we should be.
Cycles have been happening since the beginning of recorded time, yet we continue to act like good times and bad times will both endure. The smart CFO understands this and looks for the signs of sustainability before expecting past performance to be any sort of guarantee of the future.
Gregory V. Milano, a regular CFO columnist, is the co-founder and chief executive officer of Fortuna Advisors LLC, a value-based strategic advisory firm. Copyright © Fortuna Advisors LLC. All rights reserved.