Editor's note: This story was originally written going into 2023 and has been added to our CNBC Investing Club white paper vault. This is the kind of in-depth reporting on the markets that Club members can expect. It's not unusual for a company's stock price to soar—or sink — on news of a CEO shakeup. When Mary Dillon, revered on Wall Street for her eight-year run at Ulta Beauty (ULTA), was named to the top job at Foot Locker (FL) last year, the shoe retailer's stock jumped 20% in a single session. Dillon's track record of turning Ulta around is why the Club started a position in Foot Locker back in March. We hope she can work her magic again. The reaction to Dillon's appointment highlights a CEO's outsized influence over a company's direction — and perception by the market. In fact, up to 45% of a company's performance is tied to a CEO's influence, according to estimates from McKinsey & Co. So, CEOs matter when picking stocks—and at the Club, these are the five things we look for when evaluating the leaders of our holdings. 1. Capital Allocation An important question to consider early on when evaluating a CEO is their track record of spending the company's money. Have they done so wisely, in a way that over time has created value for shareholders? Or is there evidence of poor capital allocation decisions that have produced unsatisfactory results for investors? Assessing the quality of those decisions requires determining whether a CEO has overseen smart and beneficial acquisitions over the years, in addition to making appropriate internal investments that power organic growth. Investors also must evaluate a company's approach to dividend payouts and stock buybacks, two ways management teams can return excess profits back to shareholders. Well-run, mature businesses should generate enough cash to support steady increases to their dividend payments, which bolster total return on investment, and continued share repurchases, boosting shareholders' ownership percentage. Buybacks can also be an opportunistic way for a management team to reduce its share count at favorable valuations. Each of these capital allocation strategies carries benefits and shortcomings — and are, at times, in competition. For example, cash spent on an acquisition or new project could also be used to pay down debt or buy back stock. It's on management teams, led by the CEO, to choose a mix for their enterprise that maximizes shareholder value. Jim Cramer has long been a proponent of buybacks and dividends (or both) in picking stocks. Most of the stocks in the portfolio offer at least one of them. The recent shift in capital allocation decisions seen from many oil-and-gas companies, including Club holding Pioneer Natural Resources (CTRA), highlights that dynamic. Gone are the days when these exploration and-production (E & P) firms invested heavily in expanding drilling capacity. Instead, publicly traded E & P companies are allocating a larger share of profits toward stock buybacks and dividends. In the four years prior to the Covid pandemic, Pioneer's capital expenditures of $11.76 billion exceeded its net operating cash flow of $9.95 billion. In 2021 and 2022, by contrast, Pioneer's capital expenditures were just 42% of net operating cash flow, while dividends and buybacks jumped. The company's return on invested capital went from 3.485 on average between 2016 and 2019, to 9.36 and 27.14 in 2021 and 2022, respectively. Return on invested capital, or ROIC, is a profitability metric that sheds light on whether companies' investments create value. The higher, the better. Mergers and acquisitions are another important type of capital allocation. Did a CEO overpay for a business, or does a CEO have a track record of buying good companies at fair prices that enhance the entire enterprise? Danaher (DHR) fits the bill here, especially with the success of its GE Life Sciences acquisition. Now called Cytiva, the division has seen its operating margins expand to roughly 40% from around 35%, in just its second year under Danaher ownership, analysts at SVB Securities estimated in a research note last month. While Danaher, currently led by CEO Rainer Blair, has seen its business enter a rough patch this year, its demonstrated ability to wisely allocate capital undergirds the Club's long-term belief in the company. A stock's day-to-day and even month-to-month performance may not truly reflect how well a CEO is leading a company. But if management teams make effective capital-allocation decisions and are guided by maximizing return on investment, this will eventually show up in the stock price. 2. Navigating External Pressures CEOs are powerful — but not powerful enough to control the health of the global economy, so they're bound to encounter slowdowns and other tricky macroeconomic situations. How Starbucks (SBUX), a Club holding since August 2022, navigated the early days of the pandemic is one example of a company responding to developments outside its control. The public-health crisis threw a wrench in Starbucks' normal operations, initially prompting the company to shutter coffee shops. But, as stores reopened, the company's leaders leaned into drive-thru, mobile orders and delivery to ensure they could still serve customers. The coffee chain's overall sales understandably took a hit. But the adaptability of management led then by Kevin Johnson, whose five-year tenure ended in April 2022 — was notable and prepared the company for what proved to be a durable shift in consumer behavior. At its peak during Covid, drive-thru, mobile and delivery orders accounted for nearly all of Starbucks' U.S. sales. It has moderated some, but in the three months ended Jan. 1, that percentage still stood at 72% — firmly above the roughly 60% pre-Covid figure. A high-quality CEO needs to be willing to make tough decisions to protect their enterprises for the long haul while demonstrating flexibility. In recent months, Marc Benioff and Mark Zuckerberg, the top bosses at Club holdings Salesforce (CRM) and Meta Platforms (META), respectively, have successfully responded to investor pressure amid slowing revenue growth and shrinking corporate valuations. Benioff and Zuckerberg ultimately did what investors wanted, cutting back on spending and laying off thousands to boost profit margins during a period of sluggish revenue growth. Those are difficult decisions, no doubt, but ones that were crucial to restoring shareholder confidence and protecting profitability. Over at Humana (HUM), also a Club name, we've seen impressive decision-making from the C-Suite after the company's Medicare Advantage (MA) offering lost its luster in the 2022 enrollment period. Humana CEO Bruce Broussard course-corrected in impressive fashion. After last year's stumble, Humana embarked on a $1 billion valuation-creation program, with the backing of Jeff Smith's activist fund Starboard, and invested those savings in an improved Medicare Advantage offering that contained more benefits at competitive pricing. It worked wonders, as Humana has raised its 2023 membership growth estimates four times since September. Humana now projects at least 775,000 new MA enrollees, up 17% from 2022 levels and above the industry average, according to the company. 3. Customer-focused At a basic level, a company needs to satisfy its customers to ensure they keep spending money on the goods and services it offers. Establishing loyalty is valuable whether the customers are individuals buying, say, cell phones, or other businesses subscribing to software services. In fact, consultancy Bain & Co. found companies with top-tier customer loyalty grow revenues more than twice as fast as peers, and deliver outsized shareholder returns. Craig Jelinek, who's led Club holding Costco (COST) since 2012 and has been at the wholesale retailer for nearly four decades, checks this box with authority. Costco is a classic example of a customer-driven company, aiming to be the first retailer to lower prices and the last one to raise them — an ethos that's been on display as U.S. inflation rose to multi-decade highs. The result has been membership-renewal rates at record levels. "We're the price police," Jelinek told CNBC in December. "You pay to shop with us. Our job is to lower prices," he said, adding that the retailer was "absolutely" negotiating with suppliers to roll back price hikes implemented during the pandemic. Costco also has been reluctant to raise the price of its annual membership — even though it'd likely face little resistance — because management indicated it didn't want to add to the inflationary burden customers felt in their everyday lives. A pair of the Club's technology giants — Amazon (AMZN) and Apple (AAPL) — have historically been led this way. For example, Amazon's Prime membership provides customers more value than what they pay for their subscription. And the company, led by CEO Andy Jassy, continues to invest in Prime benefits to not only generate new sign-ups but retain members. Recently that's included bolstering Prime Video with exclusive Thursday Night Football broadcasts and last year's MGM studio acquisition. Amazon also has invested in its logistics network to offer one-day and same day delivery in certain situations. Apple CEO Tim Cook, meanwhile, cares so deeply about the customer experience that he's reportedly glad his email address is easily found online. Cook's morning routine begins with reading through the emails he receives from customers, according to a recent GQ magazine profile. Cook and Apple's focus on delivering high-quality products loved by customers has translated to best in-class loyalty scores and an incredibly valuable ecosystem. And that ecosystem serves as the foundation for Jim Cramer's "own it, don't trade it" mantra for Apple. 4. Accountability to investors CEO accountability is key for investors like us. Simply put, we want CEOs to offer reasonable and achievable goals, because consistently doing so over time will establish credibility and trustworthiness. Management teams often will lay out their multiyear targets for revenue and earnings, but those outlooks need to be scrutinized relative to a company's history. Has management in the past set lofty goals and fallen short? This is what happened with former Club holding PayPal (PYPL) in February 2022 when it walked back its 2025 target for active users. The stock tumbled 24.6% on Feb. 2, 2022, the session after that announcement, which was paired with a weak earnings outlook. PayPal shares are down more than 60% since their close on Feb. 1, 2022. Its veteran CEO, Dan Schulman, is set to retire at the end of 2023. Conversely, there are management teams that under-promise and over-deliver, which is what we've seen with Linde (LIN) over the years. Its bankable current chief executive, Sanjiv Lamba, has been with the industrial gas giant for more than three decades and in the top job since March 2022. Linde delivered an earnings beat and guidance raise in its quarterly results 16 times in a row, as of its fourth-quarter 2022 report. Lamba has managed Linde in a steady manner, despite operating in a sector that's seen as cyclical — and that's reflected in Linde shares commanding a premium to its industry benchmark, according to FactSet. Indeed, price-to-earnings multiples can often be proxies of management teams. If the market believes a company can consistently hit its forecasted numbers, the stock can be rewarded with a higher multiple relative to peers. Trust has value, and the stocks of companies led by reputable CEOs with competent management teams can trade at premium valuations. 5. Delivering innovation We like to invest in companies that can innovate and deliver new products. This can help companies keep their position in a market — or, better yet, expand their presence. CEOs play an important role in this process. Consider Club name Eli Lilly (LLY), which has been run by CEO Dave Ricks since 2017. The pharmaceutical giant's robust drug pipeline is a key reason we've invested in the company and why many on Wall Street believe it has best-in-class growth prospects. Eli Lilly's clinical success rate is now more than 10%, up from less than 4% in 2017, according to the company. Its research-and development (R & D) productivity also stands out among peers, based on investment data from 2014 to 2020. The star of the show is Mounjaro, Lilly's type-2 diabetes treatment that's shown immense promise to treat obesity and other ailments like sleep apnea. Mounjaro, which hit the U.S. market for diabetes in the summer of 2022, has gotten off to a very strong commercial start in the early innings. Jim has said it could become the best-selling drug of all-time, assuming its approved uses expand to obesity and beyond. Lilly also recently found success in a largescale Alzheimer's drug trial and plans to file for full U.S. regulatory approval of its potential treatment — a long time coming for the company, which has spent billions of dollars on unsuccessful drugs in hopes of finding a treatment for the memory-robbing disease that affects tens of millions of people around the world. Similarly, the reception around Ford Motor's (F) initial electric vehicle models is another example within our portfolio of a company delivering new products that are highly regarded by Wall Street. Its first all-electric performance SUV, the Mustang Mach E, has won a slew of awards, including EV of the Year in 2021 by Car and Driver, a closely followed industry publication. Demand also has been impressive for Ford's F-150 Lightning, prompting the company to expand production targets for the truck. These milestones have occurred under the watch of Jim Farley, who took over as Ford's top boss in October 2020 when the American automaker had been mired in a rut for roughly a decade following the Great Recession. Farley has stumbled, which we saw in Ford's ugly fourth-quarter 2022 results, but his response to those setbacks has been what's mattered most to the market. Farley restored our faith in Ford's latest quarterly print, putting the focus back on the CEO's plan to deliver profitable growth amid the critical EV transition. For many years, Elon Musk's Tesla (TSLA) had been eating the lunch of legacy car companies like Ford. Farley has not ceded the future and established Ford as a real player with its existing EV fleet.
