CHAPTER 1

THE QUEST FOR THE HOLY GRAIL

This book is about greatness and specifically about Caterpillar Inc., a superbexample of a once struggling company made great by a deliberate sequence ofastute management decisions. Caterpillar today is the world's leadingmanufacturer of construction and mining equipment, diesel and natural gasengines, industrial gas turbines, and diesel-electric locomotives. Financialanalysts say that its global market share is increasing and that it is churningout profits.

But things weren't always this way. In 1984, Caterpillar lost $1.17 millionevery day as it suffered through its third down year in a row. There werewhispers that bankruptcy could be somewhere down the street if CAT (this is howmost people close to the company affectionately refer to it) could not turnthings around.

However, turn things around is precisely what Caterpillar did even as manysimilarly situated firms fell into the ditch. In 2012, Caterpillar was rankednumber 46 on the Fortune 500 list of the largest American corporations, up fromnumber 58 the previous year. Its composite revenues and sales were $65.88billion in 2012, a tenfold increase since 1984. In November 2012, Caterpillar'sannual sales were 1.9 times as large as those of its nearest Americancompetitor, Deere, and 2.7 times the size of those of its largest internationalcompetitor, Komatsu.

Between January 2, 2001, and January 2, 2013, CAT's stock price rose an amazing443 percent while the S&P 500 increased only 12.3 percent. Further, thecompany's dividend per share increased 269 percent between 2001 and 2012 and nowhas increased 20 years in a row.

By any standard, these achievements represent conspicuous success and helpdefine what it means to be great. Nevertheless, the topic of good versus greatis once again in vogue because on closer inspection, so few things seemgenuinely great. Not in the United States, not in Europe, and not in the BRICs(Brazil, Russia, India, and China) either. Consider the implications of thisassessment. It's increasingly difficult to find the qualities usually associatedwith greatness either in countries or in companies. The BRICs, for example, usedto be synonymous with dynamic economic growth, but now that their growth hasdecelerated, they appear more vulnerable, and it is possible that they may leadthe world into recession. It seems apparent that the global economic environmenthas changed, perhaps not forever but certainly for the foreseeable future.

As authors and as businessmen, we have glimpsed greatness a few times during ourcareers. Truth be told, getting a small whiff of it in our prior experiencebuilding Esmark, Inc., and Shale-Inland (both billion-dollar steel-relatedenterprises) made us eager to explain why some organizations are able to scaleto higher levels of productivity and performance while others flame out and fallshort. We sense that we're not the only ones who want to know why. This is atopic of great interest not only to directors, CEOs, and managers of companiesbut also to investors large and small.

Unfortunately, never in our lifetimes have so many managers and investors beenso confused and uncertain about what constitutes the path to great businessperformance.

In today's equity and bond markets, this insecurity translates into massivedoubts about how and where one should invest. It is not a mystery why this isso. Unmistakable uncertainties exist with respect to Europe's ability to workthrough its financial crises, the Middle East is a tinderbox, the Chineseeconomy has slowed, and Japan appears to be in the middle of yet another lostdecade.

In the United States, no one really knows how the new health-care legislationwill work or what it will cost. Nor do we know what our tax rates will be nextyear, much less five years from today. How will we pay for anticipated spendingon entitlements? Our burgeoning national debt waits to be paid by futuregenerations. The list of uncertainties is long.

Hanging like a cloud above all our heads is the reality that 14.3 percent ofAmericans were unemployed or underemployed in June 2013. Regrettably, this meansthat many millions of individuals are being forced to start over in theircareers, sometimes at a terrify-ingly late stage of their lives.

Some have responded bravely to these circumstances by taking the plunge andstarting a new company. Not only do these entrepreneurs need to make the rightchoice with respect to what kind of business they should start, but also theyneed an understanding of what generates organizational greatness so that theycan rely on these principles from the very start. In light of the fact that only8 percent of new businesses reach 29 employees within 10 years, individualsinvesting their precious cash reserves want to know how new firms can grow tobecome great firms as well as how to plan for the troughs in economic activitythat inevitably will occur.

Even the more fortunate among us face uncertainties because the world is inconstant flux. Who is willing to stake his or her 401(k) balance on what therelationship between Israel and Iran will be five years from now? Who is capableof telling us what the capital gains tax rate will be five years from today orwhether the promising "reshoring" of manufacturing into the United States willcontinue? Hence, even those who are invested intelligently today couldexperience unanticipated financial distress tomorrow. We all have a need to knowhow to identify management excellence within firms so that we can utilize thatknowledge in the stock market.

Thinking About Today's Investment Environment

James Tobin and Harry Markowitz are academic titans. Each won a Nobel Prize ineconomics for advancing our knowledge of the best ways to invest funds anddevelop optimal financial portfolios. However, in the decades since Tobin andMarkowitz won their Nobel Prizes, investing has become more complicated, ways toinvest have grown appreciably since the 1980s, and these new opportunitiesusually are more complex. Consider financial derivatives. Although some kinds...