RENN Capital Group President and CEO Russell Cleveland talks with the Opportunist’s Managing Editor Leslie Stone about his company’s Founder-Owner concept of investing, which market sectors hold the most promise and what it takes for entrepreneurs to succeed in today’s economy.
During his 50-year career in the investment business, Russell Cleveland has learned that if the people at the top of a publicly traded company are significant owners in the company’s stock, that stock could possibly be a big winner. “I call it the Founder-Owner concept and it’s real simple: invest only in companies where your senior management are major stock owners because their interest and your interest are aligned,” he explains. “Take Apple for example. If you had invested in Apple in 1997 when Steve Jobs came back and it was trading at $3 per share, just think of the gains you would have made at $3 to $600. If you made a $1,500 investment in about 100 Walmart shares when Sam Walton took the company public in the 1970s, you would own over 200,000 shares today worth over $10 million. We are talking about mega gains with any amount of money you would have put in. It’s the same with Warren Buffett and Berkshire Hathaway, Larry Ellison and Oracle Corp., Phil Knight and Nike and Starbucks with Howard Schultz. What I found is if you’re patient and have a portfolio—and I say portfolio because if you pick just one Founder-Owner stock it invariably will be the wrong one.” In other words, if the Founder-Owners of a company are heavily invested in the company’s stock they are going to do everything in their power to ensure the company’s success. “Think back to when we had the big financial meltdown in 2008,” Cleveland continues. “Only one automotive company didn’t need a bailout and that was Ford Motor Co. Why? Because when times got tough the family-owners, i.e., Ford family came through and the company didn’t need a bailout. Meanwhile, the professional management at GM failed miserably. If I had my life to do over again I would buy a portfolio of maybe 10 to 20 Founder-Owner stocks and not really worry about what the Federal Reserve and the economists are saying. I would be very patient and go with these people who continue to do well. If in 1968 I had just invested say $25,000 into Berkshire Hathaway when Warren Buffett took it over—and that was kind of a reverse takeover—I would have over $100 million today.”
His concept does require due diligence, Cleveland says, because management will often show up as owners when they really only have stock options. “Founder-Owners are people who have their own money at stake. People take care of their own money better than other people’s money. Founder-Owner is a very interesting concept. It’s something that, just like with anything else, you’ve just got to know how to do it. You cannot be scared out of your stocks. You have to be patient because it’s a long-term strategy, but it does work.”
Cleveland and associate, Eric Stephens, have been running an index at RENN Capital that is based on the Founder-Owner concept. He says as of June 30, 2013 it is up 144 percent over the past three years when compared to the Russell 2000 at 75 percent and the S&P at 68 percent. “We don’t publish our index but we could,” he says. “We have 279 companies in the index, including big companies, mid-size and small. If you had been investing with this index over 10 years you would be up 228 percent. You would have done best in midcaps because the last 10 years haven’t been as good for the smaller companies. The point I want to make is if you are patient and invest in a portfolio as opposed to simply picking the popular stock of today, then you have the probability of doing well.”
Opportunist: How did you get into the investment business?
Russell Cleveland: I grew up in El Paso and attended El Paso High School, where I played tennis and music. Quite by luck, a gentleman from the University of Pennsylvania came to town and said he thought I would do great at the Wharton School and offered to help me get a scholarship. As fate would have it, I ended up there and was captain of the tennis team and graduated in 1961 with a plan to go on to law school. Then I took an introductory course on the study of law and thanked the professor because I decided I definitely wasn’t going into law. After graduation I went to work for Kidder, Peabody & Co., an old-line brokerage firm that had underwritten AT&T and companies like that. That was back in the old partnership days. I had a good experience there and met a lot of interesting people and learned a lot. In 1964, after several years at Kidder, Peabody & Co., I came to Dallas and I have been here ever since. I joined several regional firms, the largest of which was Rauscher Pierce—now part of the Royal Bank of Canada—where I was head of the research department. It’s astounding how few firms that were around 50 years ago are still here today.
Opportunist: Please tell us about RENN Capital Group.
Russell Cleveland: I founded Renaissance Capital Group, which is now RENN Capital Group, in 1972. We have been around for 41 years and have always been an investor manager, primarily handling private partnerships for wealthy families and individuals in the $5 million to $20 million range. This has been very successful for us. We would get X dollars and we would invest and work with these companies and five years later we would liquidate and everybody would go to the bank. In recent years our focus has been on closed-end funds. We have been involved in a substantial fund in Great Britain for a number of years. We have never been a mutual fund manager company in the sense of open-end funds; we tend to focus on smaller entrepreneur funds that invest in 10, 20 or 30 companies and then liquidate and pay our investors cash returns. Our main business here has always been investment management and helping companies go from point A to point B. Of course, we have had some companies that haven’t succeeded. Our specialty is small-cap growth areas or microcap companies—early stage or later stage—under $500 million. That is all we really do—and turnarounds too. We have never invested in large caps such as AT&T.
Opportunist: You are known for your optimistic approach to the market. Why is that?
Russell Cleveland: I think optimism always works better than pessimism—unless you are writing a book. I prefer the word realist. If you want to start companies and make money and succeed in this world, you have to be optimistic to make things happen. Pessimism has very rarely worked in the stock market or in business.
Opportunist: What are some of your best-performing small-cap stocks?
Russell Cleveland: One of our best-performing stocks in the 1970s and early 1980s was a company called Service Corporation. This was an NYSE listed company in the business of acquiring funeral homes all over the U.S. Service Corp. eventually became the largest provider of funeral and cemetery services in the country and its share price went from $3 to over $300—100 times your money—and even became Peter Lynch’s favorite stock at one point. We have been out of it a long time now, but it was a very successful company for us. Another big winner for us in the last decade was Laserscope, a California-based company that provides minimally invasive surgical systems. We joined the party and invested money when the stock was about $1.20 on the board. The stock went as high as $40 and the company sold for $34 a share.
Opportunist: What is your favorite market sector?
Russell Cleveland: We have always been interested in technology—particularly medical technology—and Laserscope is an example of something that worked very well for us. I could go on and on … we have obviously had some companies that were unsuccessful—usually due to a management problem. We are looking for companies that can grow rapidly given X amount of money.
There are new entrepreneurs coming in all the time and lots of them are in the connected world of Facebook and Google and things of that nature. I believe we have moved from the Industrial Age to the Knowledge Age, meaning computers and software, and now we are in the Connect Age. This is very important when looking at investments. The Internet is something very new and exciting.
Opportunist: What does it take for an entrepreneur and/or small business to succeed in today’s market?
Russell Cleveland: First, you need a good idea and a unique product or service that has some special advantage in the marketplace. What’s great about today is the Internet and this whole Internet connected world that gives companies the ability to grow rapidly through worldwide distribution. To be successful, you have to know how to run a business, generate revenues and control costs. Most of all, you have to be willing to meet challenges because there’s some type of challenge almost every single day. The late British historian Arnold Toynbee said all history is about meeting challenges—challenge and response. Your success is dependent upon how willing you are to do whatever it takes in terms of commitment and challenges. Some entrepreneurs can meet challenges and others cannot, but the most successful entrepreneurs meet challenges head on. Failing is part of winning and if you’re afraid to fail you will never do anything. You have to fail sometimes before you can win. Think of it as a game where sometimes you win and sometimes you lose. Nobody wins 100 percent of the time in sports. I have never lost a golf tournament and there’s one reason why: I have never played one.
You must give value in your product or service and you also must receive value back, i.e., positive cash flow because, no matter what Wall Street says, from time to time profits do matter. Making a dollar and losing a nickel won’t make you successful. Most successful entrepreneurs I know also have a knack for working with and managing other people. They understand that their most valuable asset is their team and they reward their team.
Opportunist: As a portfolio manager and investor, what’s your greatest fear in the markets right now?
Russell Cleveland: Well, the greatest fear is government itself. At the Federal level, we are spending a whole lot more than we are taking in. The government is out of control. There’s a litany of agencies that keep getting bigger and bigger and are a drain on the economy. Look at the IRS, the FCC and the EPA, for example. And then there is the whole entitlements program, such as retirements and so forth, and many of those are good programs and necessary, but we need to balance the money we take in. Obamacare is a bad threat and the average person has no idea how bad that will become. We really must get control of government spending. Bigger deficits and bigger government means that economic growth is going to be stifled.
Opportunist: Do you believe America’s manufacturing base can make a comeback?
Russell Cleveland: My view is that we probably aren’t ever going back to where we were because our labor costs are just way too high. Take Apple, for example. Apple products are designed in California but made in China. I have traveled extensively in China and visited a lot of factories there, and I seriously doubt we could make an Apple product in California and remain competitive. It would be great to get manufacturing back and if you can manufacture with automation then we can certainly be competitive. We do have people who know how to do automation. In terms of the connected economy, we are the leaders in the whole Internet space and I believe we can continue to dominate that.
Opportunist: What inspired you to write your book Finding Midas: The Way to Mega Stock Gains and how long did it take to complete the project?
Russell Cleveland: My book came out in 2007, and it’s a very quick read based upon the idea of CEO investing. I don’t think we used the term Founder-Owner in the book, but we do prefer that term because most people think entrepreneur means venture capitalist. But Warren Buffett is not in venture capital. It took me quite a while to get all these ideas down on paper. If I could start life over again, I would focus on the central theme of entrepreneur investing and use a checklist.
Opportunist: What type of checklist?
Russell Cleveland: I would find out if the CEO and the management team are significant owners in the company. Is the company profitable and reasonably priced? You only need four or five items on your checklist to be successful … but you need patience. If you’re the type of investor who gets up every morning and reads the headlines and listens to the economists, you will be scared right out of your investments. Investing based on a Founder-Owner approach has become a labor of love and I only wish I had known this many years ago.
Opportunist: Who inspired your success?
Russell Cleveland: I would say there are many people who gave me a real start in life. My mother was one of them. My father flew in a B-24 in World War II and never really recovered. I was never a good student until a teacher in the fourth grade recognized my work and gave me a star on a little project. It’s hard to believe that something so trivial made me realize that it’s much easier to succeed, whether in college or business or life in general, but it did and I just kept on going. There is a music professorship in my name at the University of Texas at Dallas. I became involved in the guitar world and got to know most of the great classical guitarists like Pepe Romero, David Russell and Eliot Fisk. In 1981, when I had been in business for 20 years, I sent thank-you notes and an inexpensive gold watch to the Top 20 people who had helped me—people from my college days as well as Kidder, Peabody & Co. and Rauscher Pierce and everywhere in between. I could come up with 20 more people to thank in the last 10 years alone. On October 1, 2013, I am launching World Connect Day. The concept is to appreciate and thank those who have helped you.
Opportunist: What are your thoughts on America’s economic recovery?
Russell Cleveland: I believe there will likely be some downdrafts where people will be shocked that we aren’t doing better, but I still see the U.S. economy kind of muddling through until we get a better handle on government spending and government growth. The country has fallen into this whole idea that fairness means socialism and is so focused on taxing people that it doesn’t have a clue how to get entrepreneurs going. It’s hard to create jobs when you hate the job creators. That’s the mindset we’ve got in Washington, and that’s hampering economic growth. What we need are opportunities for everybody. I believe the American Dream is intact. People need to be proactive and start thinking about hiring someone else instead of someone hiring them. Be a job creator. I am quite optimistic about where we are, and I believe there are great opportunities. You just have to think differently and stay attuned to new industries.
I believe we are in a 10-year primary bull market that started about 2008 and will continue with periodic downdrafts. We spent about 10 years in a bear market—NASDAQ hit 4,800 in 2000 and it’s only up to 3,600 more than a dozen years later. We are nowhere near where we were a decade ago. The trick is to make sure you ride along and don’t get scared out of your stocks. I am seeing the market very optimistically during the next two or three years.
Opportunist: We understand you do a lot of work with entrepreneurs.
Russell Cleveland: Yes, I do an annual Entrepreneurial Leadership Seminar at Southern Methodist University for MBA graduate students. It’s all about starting businesses, how to get going and what to look for and so forth. I put this on with several other gentlemen, and it is such an interesting topic that we are among the highest ranked speakers at SMU.
I also serve on a number of boards. One of the successful companies I am associated with is AnchorFree. They offer a service that protects your privacy online and make sure that no one, from Google to the government, will know who you are. Go to their website, www.anchorfree.com, and check it out. Once we became involved, the company started thinking about making money every day, they became very successful and currently have about 150 million downloads worldwide. Many users are in the Middle East and China. During that recent ordeal in Turkey where the government was going after people in the park, 120,000 downloads were made in just one day. The company’s Founder-Owner is David Gorodyansky. He came from Russia and founded the company in the Silicon Valley at age 23.
Opportunist: What do you enjoy most about your work?
Russell Cleveland: Working with companies that are succeeding. I believe I have gotten better at meeting challenges. I love working with companies and making money for investors, including myself—but I must tell you that I am not attached to money in terms of owning yachts and other expensive toys. What inspires me the most is seeing things succeed and working with management. I admit that it’s fun to go to the bank every once in a while—it’s all part of the game—and I love playing the game. I really do. I have always said my epitaph should read: ‘Lifetime Student.’ Let’s all keep being students.
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Leslie Stone is an award-winning writer/editor with more than two decades of experience covering business, finance and lifestyle issues for newspapers, magazines and online publications. Originally from Virginia, she currently resides in Florida. Follow her on Twitter at @les7989.