The 1960s Stanford University ‘Marshmallow Test’ gave 600 children a straightforward choice: eat one treat now or wait 15 minutes and have two. The study was designed to establish whether kids could ‘delay gratification’, with less than a third holding out long enough to receive the second treat.
It’s an interesting test of human psychology, and at times I wonder how Australian CEOs would fare given the short-termism that dominates today. The sharp focus on earnings guidance and maintaining dividends has driven such a fixation on minimising risk that many CEOs/Boards have struggled to delay gratification, instead choosing to maximise the ‘now’ and sacrifice potentially significant future growth and value creation.
This behaviour takes a few forms, but is most commonly observed through high dividend payout ratios, declining CAPEX and aggressive programs to take out costs. The mindset can provide a sugar hit for investors, but in doing so often undermines longer-term returns and the broader economy.
The recent clearest example has been the Australian telco sector, where Telstra (we have no position) has taken the first marshmallow and over the last decade has effectively harvested its fading monopoly. High payout ratios, declining investment and no earnings growth since 2009 have combined to put Telstra in a vulnerable position. Instead of choosing to invest, the company faces a 20-30% earnings hole over the next 5 years courtesy of the NBN.
By contrast, we have high confidence that TPG (a new position) would pass the test. The company has aggressively invested in high growth segments, leveraged its low cost base and grown a strong brand. Ironically, TPG is being punished by investors (-48% yy) and is viewed as ‘risky’ rather than innovative and opportunistic.
A follow up review of the Stanford University kids some 30 years later found that on average those who were able to wait for the second treat tended to have better life outcomes. For us – investors focussed on total shareholder returns – it is increasingly challenging to find companies that will pass the marshmallow test. Other than TPG, a few other favourites currently in Yarra Capital’s portfolio include Seek, Resmed and Star. We hope to find more, but with Australian CEO tenure averaging approximately 5 years the temptation to be short term is real.