Thoughts on wealth creation.
“Wealth is created through the long-term ownership of a growing business.” — Herb Ehlers, retired Chief Investment Officer of Eagle Asset Management and Goldman Sachs.
In early 1998 I met with a young couple in Virginia to discuss their financial future. As I recall, they were both physicians, slightly arrogant, but in a benevolently condescending manner to me, a mere master-degreed Certified Financial Planner. They were just getting started with no children and a nice house with minimal furniture on the water in a solid tidewater community. At the time they had a new investment in the house, a small savings account, very high salaries at a regional hospital, and one investment. The investment was a small company that had gone public a few years prior. Their thousand shares at $18 per share had grown by a factor of seven since the IPO to a current value of $125,000.
Among my many recommendations, including disability and life insurance, full participation in the hospital retirement plan, and conservative financial decisions, I recommended that they sell the one stock they owned and invest in a mutual fund that would generally mimic the S&P 500 Index. I pointed out that this stock was their only investment. They were highly concentrated and needed diversification.
They were appalled. We parted on reasonably friendly terms.
In the years since, I have thought about that young couple. Had they followed my advice, their $125,000 (maybe $100,000 after taxes) would have averaged about 7% per year. Today that portfolio, with no additions, would be worth about $290,000. On the other hand, if they held onto that one stock, as they seemed determined to do, their $125,000 would now be worth $9,800,000. Wealth isn’t created by diversifying into 500 companies. Diversification is a wealth preservation strategy. Wealth is created through long-term ownership of a growing business as I hope this now not-so-young couple learned through twenty years of ownership of Amazon stock.
Ten years ago I sold my financial practice to my son and his associates. Over time, with hard work, I had built a successful business. They paid me well and I moved on. That practice prospers still.
With solid income and some resources, I decided to establish a small private equity firm. I wanted to buy businesses, or at least make meaningful investments in those that needed capital. I knew well that wealth is created through the long-term ownership of growing businesses. Among our first investments was a small pharmaceutical company in Pittsburgh. The company had two operating pharmacies and just $5 million in annual revenue. With our injection of capital, it was then able to add five new “stores.” Six years later, when we sold the company to a much larger private equity firm, we had 100 stores and $230 million in annual sales. Our $3 million investment had grown in value to $54 million.
This was our first big success. Investing and engaging actively in the management of this business taught us lessons we could never learn in school: Business management is not for the faint of heart. Expect the unexpected. Economies grow and shrink. Competitors compete. Employees have problems. Banks are fickle. Hang tough. Do what needs doing. Never quit.
Since that first investment, we have bought more companies. We have helped them overcome problems and grow. We stay in touch; add or raise capital when needed; serve on boards; negotiate with banks; and apply technical expertise in IT, personnel management, finance, and accounting.
My primary role is to provide leadership. Here I am more often applying lessons I learned as a young Army officer in the late 1960s: Get up early. Take care of your people and yourself. Shine your shoes. Dress appropriately. Be highly visible. Make decisions decisively. Never reprimand an associate in public. Communicate clearly. Never use profane language. Tell your people that they did a good job when they did a good job.
It is thus possible to apply capital and attention to small businesses and to grow them profitably so they create wealth for those who own them over a long period of time. This is what I’ve been doing with my life for more than a decade now. I hope to do it for many more years.
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Michael (Mick) K. McMahan, CFP, is Chairman and CEO of Gaston Capital in Belmont, North Carolina.
