Water the flowers, cut the weeds

Water the flowers, cut the weeds
Why a simple portfolio management framework is relevant for private equity value creation.

Legendary investment manager Peter Lynch coined the portfolio management framework "Water the flowers, cut the weeds." In simple terms, this approach involves identifying good businesses (which he called flowers) and tending to them over long periods while exiting bad businesses (which he called weeds) as quickly as possible. This approach was later endorsed by none other than Warren Buffet and referenced in his 1988 Chairman's letter.
We are advocates of this approach for value creation at PE-owned companies. We have used it to achieve successful outcomes, with EBITDA expansion often in excess of 300bps of revenue.
So why does a portfolio management framework that works across a portfolio of stocks work well for value creation inside an individual business?
For three reasons.
One, every business is a portfolio, of smaller pieces of business. Think of a piece of business as "product or service A, sold to customer B, in region C". Such a definition is not only rooted in reality, it is concrete enough to drive action in the field.
Two, enterprise value creation is hard. It becomes easier when profitability data is available by piece of business to help discern flowers from weeds. After all, the EBITDA of the enterprise is the mathematical sum of profit contributed by the individual pieces of business, less shared fixed costs.
Three, like investment portfolios, there is wide variation in performance between the good ("flowers") and bad pieces ("weeds") of the business. Weeds are particularly dangerous for their ability to silently leak value and derail performance. They are often perceived to be flowers, depleting resources that should have gone to flowers.
There are several benefits to be gained by applying the framework “Water the flowers, cut the weeds" to your business.

• By understanding which products and customers, in what region, are driving costs and margins, a business can make informed decisions about pricing, promotions, and cost management.
• By fixing underperforming parts of the business, management can boost profits and returns, and free up cash and other resources for profitable growth.
• Measuring profit data by customer and product leads to more accurate forecasts and a better ability to prepare for emerging trends that impact the bottom-line. The business can position itself to weather changes in the market and adapt its strategy accordingly.

As a leader, it is in your interest to assess if your team has the right tools to measure and manage profitability by product and customer, so the business can successfully “Water the flowers, cut the weeds.”