Related Resources Screen for the best stocks for you See how MSN Moneys StockScouter rates a stock Find out today's big trends Related Sites Walgreen Co. Trustmark Corp. Southwest Airlines House of Representatives e-mail addresses Senate e-mail addresses Jubak's Journal Recent articles: • We need a new guard dog at the SEC, 11/18/2003 • 5 stocks to love -- that everybody hates, 11/14/2003 • Will the Dow hit 11,000? Ask the Fed , 11/11/2003 More... | Jubak's Journal Trustmark, Walgreen join my Clean Stocks list A Mississippi bank and the drug store giant really work for shareholders. Heres why -- and why Southwest Airlines didnt quite make the cut. By Jim Jubak The bad guys get all the headlines, but dont let them scare you into putting your money in the mattress. So far, my 'Clean Stocks' project, launched last July, has identified six stocks that are clean enough for investors who worry about the never-ending round of financial scandals yet know theyve got to stay in the markets to stand any chance of reaching their own financial goals. In this column, Ill add two more names to my list and nominate three other candidates for due diligence. Its not easy to find the good guys. After all, CEOs like Dennis Kozlowski and mutual fund managers like Richard Strong get the headlines and the TV time.
The good guys are ignored, except by smart investors. These investors know that not all mutual funds see Job No.1 as filling managers pockets by ripping off shareholders. The Dodge & Cox family of funds, for example, combines above-average gains for investors with below-average expenses. Rather than waiting for U.S. Securities and Exchange Commission regulations, the Fidelity group of funds rigorously applies fair value pricing to prevent stale pricing at its international mutual funds. The Tweedy Browne fund family makes a habit out of fighting for shareholder value. Its successful efforts to oust Conrad Black as CEO of Hollinger International after Black and other company executives accepted $32 million in unauthorized payments produced a one-day gain of $30 million for shareholders of the companys funds. And, of course, theres the Vanguard group, which has a policy against late orders thats still way ahead of any of the reforms now being proposed by the SEC or Congress. And not all CEOs of publicly traded companies behave as if the company belongs to them, either. For every Bernie Ebbers, Dennis Kozlowski and Richard Scrushy, theres a Peter Rose or a George Roche. Rose, the CEO of Expeditors International  Watch MSN Money's Countdown 2003 on CNBC What were the year's big financial events? Which story is No. 1? Editors and writers for CNBC.com on MSN will offer answers on "Countdown 2003.
• Show preview: Who's the biggest scoundrel? Never heard of Rose or Roche? Probably not, because all theyve done is run their companies in ways that investors can trust. Digging to find companies that you can trust with your money is worth the effort. For the last 10 years, the cumulative return on the Standard & Poors 500 ($INX) stock index is 126%, and its 152% on the Nasdaq Composite index ($COMPX). In the same period, shares of T. Rowe Price are up 539% and Expeditors International 2,156%. Stocks of companies that behave well toward shareholders often are, but obviously not always, superior long-term investments. Thats the premise behind the growing list in my Clean Stocks project. The process works like this. Each month or so, I nominate three candidates for inclusion on the list from suggestions that readers have sent me. That lets us harness the combined knowledge of everyone who reads Jubaks Journal. In the month after the nomination, I do due diligence on each stock, and so do readers who send in whatever they know about them. At the end of that, I report which companies made the list and which didnt and why. And ask for another three nominations. If at any point a reader or I come up with something that makes us question the companys place on this list, Ill review the selection. Companies and their stocks are judged in eight areas: executive compensation, accounting, conflicts of interest, growth strategies, corporate structure, options accounting, pension accounting and potential return to investors. Clean Stocks almost certainly will have a blemish or two, but the bad marks should be limited, and, ideally, immaterial to their investment quality. (For a full description of each of these standards, see my Sept. 19 column, 2 more stocks pass Clean Stocks' test.) Last months nominees were: Lets see how they did. Southwest Airlines: grounded because of options accounting I suspected options accounting might present problems for Southwest, and it did. I think the issue is serious enough to keep the company off the Clean Stocks list -- especially because it is facing future pay pressures that will put options front and center. The problem isnt that Southwest is stuffing its executives pay envelopes with options, an all too widespread problem these days. Executive cash compensation is below airline-industry average at Southwest: Chairman Herb Kelleher received just $431,000 in salary and $170,000 in bonuses in 2002, and CEO James Parker was paid $305,000 in salary and $287,000 in bonuses. And Southwest doesnt overdo options to compensate. Kelleher and Parker each received option grants equal to just .02% of all options granted to employees in 2002. Thats about what Id expect from a company thats up to the most exacting standards of corporate governance. Auditors Ernst & Young make almost all of their money from auditing the books without big consulting contracts as an incentive to look the other way on accounting infractions. Even by my conservative count, eight out of 12 members of the board qualify as independent. The companys options accounting, however, doesnt meet the same high standards. Southwest doesnt count options as compensation. (And as Warren Buffett said, if options -- paid to employees in exchange for their work at the company -- arent compensation, what are they?) In 2002, counting options as compensation to employees would have turned Southwests earnings of 30 cents a share into 23 cents a share. Thats a 23.3% swing. And thats too much, considering that options are a key reason that Southwests labor costs are below those of other airlines. The company historically has made up the difference -- and then some, considering the stocks performance -- with options. Employee gains from options have helped the company win the kind of flexible scheduling and high productivity from Southwests intensely loyal employees that give the company a cost advantage over competitors. The stock has faltered -- shares are down a cumulative 10% over the last three years -- and the pressure to increase salaries has grown. Will that mean Southwest will grant more options in an effort to keep cash compensation low or will the uncertainties in the airline industry make its employees demand more cash? Its hard to tell how future compensation issues will affect earnings since the company doesnt expense options as compensation now. Trustmark: The banking company gets a Yes Bank accounting requires a lot of trust from investors. Are bad-loan reserves really enough to cover write-offs? Is the bank taking big risks in its hedging against risk? Are securities in the banks portfolio really marked to fair value? Theres really no way for most investors to tell so it all comes down to trust: Do you trust that the people running the bank are telling the truth. Id say yes at Trustmark, a bank with 150 offices in Mississippi and Tennessee. Heres why. The company, headquartered in Jackson, Miss., set up its governance committee in 2000, before the issue became fashionable. The audit and finance committee meets with internal and outside auditors regularly without management, something recommended in the latest round of reforms. And the company has a clear and anonymous method for reporting fraud posted prominently on its Web site for employees and the public, along with a promise not to retaliate against whistle-blowers. The rest of my due diligence supports that picture. Expensing options wouldnt change earnings per share. Ten out of 12 directors are independent by my definition. Auditor KMPG makes $471,000 from auditing the books and only $73,000 from other work. Tricky categories that give banks a chance to fudge earnings like gains on sale of loans are a small part of total income. The company did grow by acquisition in 2003, but the deal was to add seven bank branches in Florida and put just $48 million in good will on the books. Blemishes? Executive compensation needs watching, as does the concentration of power that combines the offices of chairman, president, and CEO in one executive, Richard Hickson. Hicksons 2002 cash compensation isnt out of line at $550,000 in salary and $550,000 in bonus, but his 2002 grant of 45,000 options represents 11.5% of all options granted to employees that year. Walgreen: yes, because of steady-as-she-goes management I think Walgreens management proved itself in the drug store wars of the 1990s. While all of its competitors were busy bulking up by acquiring smaller drug chains, Walgreen concentrated on internal growth. Now that many of those same competitors are busy disgorging those acquisitions either through store closings or bankruptcy reorganizations, Walgreen looks awfully smart. This is the kind of steady-long term thinking -- and execution -- that characterizes just about everything about Walgreen. The company has no long-term debt, but with Walgreens cash flow, $1.5 billion from operations in 2002, the company has plenty of internal cash to use for expansion. Walgreen has doubled its store base to a current 4,200 over the last decade. Management is home-grown. The company has had only five CEOs since Charles Walgreen founded it in 1901. Current CEO David Bernauer has worked for the company 35 years, and President Jeffrey Rein began his career as a pharmacist. The companys governance looks solid, too. Independent members make up seven out of 10 on the companys board. Auditor Deloitte & Touche is paid $455,000 to audit the company and $371,000 for all other work. And Bernauers pay of $763,000 in 2002 and $490,000 in bonus is about average these days. No company is perfect. Bernauer got 10% of all options granted to employees in 2002. Thats extremely high, but 75% of those options were a special grant that he received upon taking over as CEO. So, while it bears watching, its not enough to make me bump the company from Clean Stocks. The company has $129 million in off-balance-sheet letters of credit to suppliers among others. While that also bears watching, it isnt too worrisome at a company with no long-term debt. The addition of Trustmark and Walgreen to the Clean Stocks list brings membership to eight stocks. The other members are:
Nominees for due diligence for the next round are Warren Buffetts Berkshire Hathaway Thanks to everyone who made these and other suggestions for the clean stocks list. Please remember to e-mail me with new nominees (old nominees are held over for future consideration) and with any comments you have on the stocks now on the list or those now under the microscope. Expect the next report around mid-December. New developments on past columns Lost in the market fog? Follow the dividends The courts take away and the courts giveth. A week after an Alabama jury found that Exxon Mobil We need a new guard dog at the SEC On Nov. 18, the House of Representatives passed a mutual fund reform bill, HR 2420, by a vote of 418-2. Its better than Securities and Exchange Commission Chairman William Donaldsons limp recommendations for reform, but its still just a start. Whats needed now is a stronger bill from the Senate that builds on this foundation. My thoughts on critical improvements that need to be made include:
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does own shares in mutual funds Dodge & Cox International Stock and Dodge & Cox Common Stock. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||
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