Many international smid-caps have far longer operating histories than US companies, but are actually in an earlier stage of corporate evolution.
The family founders of many of today’s US smid-cap companies sold out long ago and left them in the hands of professional managers.
In our view, family-owned businesses may offer a structural business advantage over former family companies that sold out.
The company being their figurative “baby,” families tend to finance them from operations, instead of turning to lenders.
An advantage for shareholders in family businesses abroad is their fairly generous dividends.
It’s Thanksgiving season in the US, and our thoughts turn to family – which makes this a great time to explore the topic of family-owned businesses and some of the misperceptions that seem to surround them.
Some investors fear that family-owned businesses, especially those without an independent board of directors, may not prioritize their shareholders’ interests and, by extension, may produce less reliable or inferior investor outcomes. That perception, however, doesn’t bear up under scrutiny.
Family-owned companies are more prevalent internationally
This is particularly important for investors in international small- and mid-cap stocks (or “smid caps”) – which is our team’s focus. Family businesses are more common abroad, especially among smid-caps.
For example, consider the CS Family 1000, Credit Suisse’s (NYSE:CS) proprietary database of more than 1,000 publicly traded companies with a family or founder who has at least a 20% holding in the firm. Nearly 50% of these companies are located in Asia and 25% in Europe, while only 14% are in the US.1 In a recent study of their performance, Credit Suisse found that since 2006, they substantially outperformed their non-family owned peers – by 370 basis points annually on average.1 Furthermore, they generated more revenue and were more profitable.1
We have been analyzing, evaluating and investing in companies around the world for many years. Many international smid-caps have far longer operating histories than US companies, but are actually in an earlier stage of corporate evolution. This, we believe, is a good thing. The family founders of many of today’s US smid-cap companies sold out long ago and left them in the hands of professional managers. Investors may associate such managers with shareholder responsiveness, but as Credit Suisse confirms, such “hired-gun” managers do not necessarily produce better shareholder outcomes.
The potential advantages of family-owned companies
In our view, family-owned businesses may offer a structural business advantage over former family companies that sold out. We believe that most family-owned companies have the following traits:
1. A longer-term notion of value-creation. Professional managers tend to focus on shorter-term issues, reflecting their own short leashes: boards and shareholders of S&P 500 Index companies replace their CEOs every five years on average.2 By contrast, family control tends to be continual, leading to a longer-term focus and horizon for investments in areas such as research and development. In this way, family businesses fit squarely into our investment process. We seek to partner over the long term with the world’s best compounder businesses, and family companies have a compatible long-term orientation. Much as we don’t invest for quarterly returns, family businesses look beyond quarters to judge their results.
2. A responsible and de-risked approach to financing. The company being their figurative “baby,” families tend to finance them from operations, instead of turning to lenders. Consider this: rough business patches are much easier to weather without debt leverage. The pain of lower revenues is not amplified by the sudden and unplanned spike in the percentage paid to service debt. In addition, internal funding provides a competitive edge. While debt-leveraged competitors are trying to figure out how to pay their bankers, a self-funded company can focus on how to take their customers. Indeed, greater financial strength during tough times may enable the outright acquisition of a weaker rival.
3. A stronger commitment to dividends and therefore total shareholder return. The third advantage we see for shareholders in family businesses abroad is their fairly generous dividends. We believe there are two reasons for this. First, these companies are typically the family’s primary source of income. Secondly, dividends are the preferred way to obtain that income. In non-US markets, especially in Europe, it is considered unseemly, or even a conflict of interest, for senior executives to trade in their own company’s shares.
As investors, we find this combination of longer-term value creation, more conservative funding, and a commitment to dividends to be very attractive. The first can sustain market leadership through innovation and opening new opportunities. The second can help mitigate downside risks for the company and its investors, especially when the chips are down. And the third may be a key source of returns, as well as income in today’s yield-starved environment.
- Source: “The CS Family 1000: Small cap family-owned companies, Environmental, Social and Governance (ESG) Research,” Sept. 9, 2020, Credit Suisse
- Sources: Harvard Law School Forum on Corporate Governance, “CEO Tenure Rates,” Feb. 12, 2018, data as of year-end 2017; The New York Times, “Many C.E.O. Tenures Are Getting Shorter,” Oct. 23, 2018
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