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Add to MSN Stock List Message Board Related Resources Cheapest stocks of large, growing companies Expectation stocks Find out today's big trends Jubak's Journal Recent articles: • 10 dogs ready to bark in 2004, 12/16/2003 • Readers answer the disappearing-jobs riddle, 12/12/2003 • Turn 2003's lessons into 2004's profits, 12/9/2003 More... | Jubak's Journal Clean enough for Buffett, clean enough for me Berkshire Hathaway and The Washington Post Co. not only meet the Oracle of Omaha's standards, they make our Clean Stocks list as well. Texas Instruments falls a little short. By Jim Jubak This month I put my eight rules for determining whether a stock is clean or not to the ultimate test. I pitted my standards, which readers helped craft, against those of superstar investor Warren Buffett, chairman of Berkshire Hathaway In Berkshire Hathaways 2002 annual report (which you can find on the Berkshire Hathaway Web site) Buffett offers a vigorous critique of the shortcomings of current reform efforts and discloses his own tests for identifying companies where the board of directors, the CEO and everyone else down the management line treats shareholder money as if it were their own. The results? The eight Clean Stock rules passed the Buffett challenge with flying colors.
And Buffetts Berkshire Hathaway passed my Clean Stock test, too. So did one of the two other nominees from last month: The Washington Post Co. I started the Clean Stocks portfolio in July and, at the time, asked readers to comment on six tests for finding stocks that investors could trust. I also asked readers to do their own due diligence on the first three nominees to the portfolio and suggest candidates for future consideration. Since then, I have reported monthly the results of that joint due diligence on the past months three stocks and put forward a new batch of three nominees for the next round. This column is the fifth Clean Stocks report. The portfolio now consists of 10 stocks:
Thanks to reader comments, the original July list of six tests grew to a final eight in September. You can find the full list in my column 2 more companies pass 'Clean Stocks' test, which appeared on Sept. 19. Buffett believes that an investors goal is to find companies where management truly runs the business for the shareholders. Members of the companys board of directors should behave as if there was a single absentee owner, whose long-term interest they should try to further in all proper ways, he argues. More on Clean Stocks Many of the procedural changes put into law in 2002 by reform efforts such as Sarbanes-Oxley or proposed by the U.S. Securities and Exchange Commission and Congress this year miss the point, Buffett writes. The acid test for reform will be CEO compensation. Managers will cheerfully agree to board diversity, attest to SEC filings, and adopt meaningless proposals relating to process. What they will fight, however, is a hard look at their own pay and perks. Berkshire Hathaway: a star in governance Berkshire Hathaway walks the walk on these governance issues. Buffett is paid the same $100,000 salary as CEO and chairman of the board that he has earned for each of the last 22 years. He made an additional $196,000 in 2002 in cash of deferred equity compensation in directors fees from non-subsidiary companies in which Berkshire has a major investment interest. This year Berkshire voted to expand its board of directors to 11 members from seven, bringing in outside independent directors as recent reforms require. But the company also has required that the new members have substantial holdings of Berkshire stock, purchased with their own money prior to their joining the board. That will, Buffett believes, align these new directors interests with the interests of other shareholder/owners. Berkshire Hathaway, says Buffett proudly, pays a pittance to its directors. They get $900 for each meeting they attend in person and $300 for each meeting they attend by phone. Other rather radical steps on governance have been part of Berkshire Hathaway policy for years. For example, the company doesnt purchase officer and director insurance -- standard policy at most big U.S. companies these days. That leaves directors legally exposed to the consequences of their actions. Which is all to the good, writes Buffett. We want the decisions of our directors to be driven by the effect their decisions will have on their familys net worth, not by their compensation. So how do investors find clean companies, according to Buffett? He boils it down to three tests.
Avoid companies that produce financial reports with impenetrable footnotes. These are most likely designed to confuse or conceal the state of the business. Beware companies that trumpet projections of future growth or earnings. No CEO is ever absolutely certain about future sales or profits, Buffett notes, and managers who rely on projections to get the financial markets excited about their stock or to meet financial goals that determine their own compensation can all too easily pass from publicizing these projections to lying to make sure their company reports the right figures. The Washington Post Co.: The family makes things right The Post company owns Newsweek, cable TV systems and the Kaplan educational testing business as well as its flagship Washington Post newspaper. It doesnt quite match Berkshire Hathaway on every test, but it comes extremely close. Not surprising, because Buffetts Berkshire Hathaway is a major shareholder with 1.7 million class B shares and Buffett himself sits on the companys board of directors. (Hes on his second stint; he first joined the Post board in 1974. Executive compensation is below market, with CEO Donald Graham making a salary of just $400,000, the same salary level that hes had since 1991. In 2002, Graham also received $216,000 in restricted stock and a $10,480 company contribution to his 401(k) plan. Dont cry for Graham, however. He owns 1.5 million class A shares and 3.5 million class B shares of the family business. (His mother was the legendary Katherine Graham.) The class B shares are worth about $2.7 billion and generate about $20 million a year in dividends. The company recently has announced that it would begin expensing options, but the effect in prior years of not expensing wasnt major. In 2002, expensing options as compensation would have cost the company about 38 cents a share, or about 2% of 2002 earnings per share of $21.34. The company projected a 7.5% rate of return for its pension assets in 2002. Thats pretty conservative relative to the 9% to 10% that other major corporations have been using in their projections. Only in the area of board makeup does the company fall short of Berkshires standards, although it certainly still meets the requirements of the Sarbanes-Oxley Act of 2002. The board, which includes Buffett, media magnate Barry Diller, Daniel Burke (the retired CEO of Cap Cities/ABC), and former Federal Reserve Board vice chair Alice Rivlin, certainly meets the acts definition of independent. But the Washington Post pays its directors, including Buffett, too much by Buffetts standards -- $60,000 a year -- and doesnt require significant share ownership by directors. On the other side, CEO Graham, with his huge ownership stake and relatively modest salary, clearly has his interests aligned with shareholders. That pays off, I think, in the companys long-term approach to building businesses and reinvesting in new growth. The educational services business finally moved to a profit in 2002 and is now the fastest-growing segment of the company. With the company poised to start reaping the rewards of it long-term investments, Im adding the stock to Jubaks Picks with this column. Why Texas Instruments doesnt make the cut What stopped Texas Instruments from joining the Clean Stocks list? Two things.
On top of that, it granted him 1.05 million stock options. The companys latest proxy statement calculates that this grant is worth somewhere between $17.5 million (if the stock appreciates at 5% a year for the next 10 years) and $44.3 million (at 10%) I dont know about your expectations as an investor, but giving a guy options worth $17.5 million in exchange for 5% annual growth in the stock seems a bit rich to me. You can find the same generous inclination to spend shareholder money in what the directors have voted themselves in compensation. Directors are paid $55,000 annually, roughly equal to the $60,000 that directors receive at the Washington Post Co. But they also get an annual grant of 15,000 options that vest over four years and a one-time grant of 2,000 units of restricted stock when they join the board. And lets not forget the $1,000-a-day fee they collect every day they do TI business. That level of compensation for the folks who are supposed to be watching out for shareholder interests makes me uncomfortable, especially because giving options to board members provides them with an incentive to manage for short-term earnings results. I dont think TI has done that to date, but the warning signs are there. Take the companys press release announcing an increase to projections for fourth-quarter 2003 earnings. The new range, the release notes, is 25 to 27 cents per share, up from 14 to 19 cents a share in the previous projection. Readers who dont get beyond that sentence, however, wont find out that part of this increase -- 7 cents a share -- will come from the companys sale of its remaining investment in Micron Technology Nothing in the release is untrue, and all the figures are there for the investor, but the release certainly fits Buffetts warning about companies that trumpet short-term earnings projections. And that makes the companys refusal to expense options as compensation even more troubling. Were talking about a lot of annual options grants here, folks. CEO Engibouss 1.05 million options granted in 2002 represent only about 3% of all options granted to employees. Thats enough to produce a sizable difference in reported earnings per share, which dont account for options, and earnings per share after options are expensed. In 2002, the company reported a loss of 20 cents a share before options expenses. That loss would have climbed to a loss of 43 cents if options were expensed. In the third quarter of 2003, expensing options would have taken reported earnings per share down 24% to 19 cents from 25 cents. My search for a tech company that can pass the Clean Stock tests goes on. But next months three nominees are a test of a theory suggested by a number of readers. Are the safest and cleanest stocks those of reformed sinners? This list includes companies that have been guilty of the biggest failures of corporate governance, and were going to find out if they now have learned their lessons. Next months nominees are Boeing As always, send me your comments on why those stocks should or shouldnt make the Clean Stocks list and your nominees for the next round in mid-January. Changes to Jubaks Picks Buy The Washington Post Co. With its mix of advertising-driven media properties and the fast-growing for-profit education Kaplan business, The Washington Post Co. (Full disclosure: I will be adding a personal position in the Washington Post Co. three days after this column is posted.) New developments on past columns 3 food stocks face a leaner, meaner world Blame it on beef. With beef prices soaring thanks to increased demand from adherents of high-protein/low-carbohydrate diets and tight supplies, Wall Street analysts have been looking for pork to pick up market share against the red meat. But that hasnt happened, and the result has been downward pressure on pork prices in the futures traded at the Chicago Mercantile Exchange. Shares of Smithfield Foods 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 owned or controlled shares in the following equities mentioned in this column: Berkshire Hathaway, Paychex and Smithfield Foods. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
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