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Boeing, Motorola, Rite Aid fail the Clean Stocks test
Theyre former corporate bad boys under new managements that have made improvements. But they haven't made enough changes to qualify for my list. Heres why.
By Jim Jubak
Who says good guys finish last? The Clean Stock portfolio that readers and I started crafting last year has beaten the market hands down.
As of the close on June 17, eight of the 10 stocks in my Clean Stocks portfolio are up since I added them to the list. The average gain for the stocks in the group from the date of the first pick on Aug. 1, 2003 to the close on June 17 is 18.5%. The Standard & Poors 500 stock index ($INX) is up 15% in the period. For 2004 to the close on June 17, a period when I didnt add any new stocks to the list and thus the Clean Stocks portfolio was fully invested, the stocks returned 8.2% on average. The S&P 500 was up 2% over the same time period.
Heres the complete list and returns:
| How our clean stocks list has performed | | Company | % return since purchase | % year to date | Purchase date | Purchase price | | Apache (APA, news, msgs) | 40.8% | 7.9% | 8/1/2003 | $31.11 | | Applebee's International (APPB, news, msgs) | 13.4% | -3.7% | 9/19/2003 | $22.27 | | Berkshire Hathaway B (BRK.B, news, msgs) | 6.2% | 4.4% | 12/19/2003 | $2,768.00 | | Expeditors International (EXPD, news, msgs) | 32.4% | 26.9% | 9/19/2003 | $36.15 | | Paychex (PAYX, news, msgs) | 17.3% | 1.1% | 8/1/2003 | $32.17 | | Stryker (SYK, news, msgs) | 40.6% | 27.4% | 10/7/2003 | $38.52 | | Trustmark (TRMK, news, msgs) | -0.1% | -0.8% | 11/25/2003 | $29.25 | | T. Rowe Price (TROW, news, msgs) | 15.4% | 2.7% | 10/7/2003 | $42.20 | | Walgreen (WAG, news, msgs) | -4.5% | -3.9% | 11/25/2003 | $36.62 | | The Washington Post Co. (WPO, news, msgs) | 23.0% | 20.1% | 12/19/2003 | $772.50 | | | | | | | Average Clean Stock return | 18.5% | 8.2% | | | | S&P 500 return | 15% | 2% | | |
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Returns as of June 17.
After a hiatus of just about sixth months, Im returning to the portfolio to update you on the three nominations that I made way back on Dec. 19: Boeing (BA, news, msgs), Motorola (MOT, news, msgs) and Rite Aid (RAD, news, msgs).
First, though, since its been so long since weve done this, a review of the rules.
I launched this cooperative effort to build a list of clean stocks last July in my column, "Join forces to build a list of stocks to trust." Over the months, readers helped me develop a final list and refine the set of eight rules that now form a test that a Clean Stock must pass to get added to the portfolio:
Executive compensation: Excessive executive compensation, especially massive bonuses for mediocre performance, large personal loans and big grants of options, are signs that the board of directors may be asleep. They also give executives an incentive to manage for short-term goals that line their own pockets.
Accounting: Financial reporting should be as free as possible of one-time charges that make it difficult to get a handle on company performance. It should give a picture of company performance without the effect of trends outside the companys control such as currency exchange and interest rate changes.
Conflicts of interest: A big danger sign: Entrenched accountants that have done the books year in and year out. Signs also include massive amounts of consulting work with the company and a lack of strong outside directors on the companys accounting, compensation and corporate governance committees.
Growth strategies: Growth by acquisition can produce a constant barrage of one-time charges and write-offs that make it impossible to judge company performance.
Corporate structure: A company with a plethora of subsidiaries and off-balance-sheet entities presents a challenge to investors trying to figure out where the cash is coming from and where its going.
Options accounting: Companies should engage in modest use of options and accounting that honestly tries to account for options as compensation.
Pension accounting: Companies with defined-benefit pension plans that are clearly understating the size of their future pension liabilities should get the ax.
Potential return to investors: Shares of the company in question should show the potential for outperforming the market over the long term. Im not looking for the business world's saints. Companies that make the Clean Stock portfolio will almost certainly have a blemish or two, but the bad marks should be limited and, ideally, should be non-material to their investment quality.
More on Clean Stocks
Have three corporate bad-boys gone good?
I chose the last group of three nominees from reader suggestions for possible inclusion on the list because they present an intriguing problem for investors looking for clean companies. Each -- Boeing, Motorola and Rite Aid -- is a past corporate governance bad boy that has brought in new management to clean house and improve performance. Have any of these companies done enough? Not yet.
Boeing: Executives too close to the Defense Department? Take the case of Michael Sears, CFO and former heir apparent to the CEO job, who got the ax from the board of directors in November.
Sears has been named in court as one of the company officials who negotiated a contract to hire Darleen Druyon, a Pentagon official in charge of billions in Air Force contracts, while she was still at the Pentagon. Druyon, who has pleaded guilty to conspiracy and faces up to five years in prison, passed along proprietary data from Airbus, which was bidding against Boeing for a $20 billion contract.
Sears was followed out the door by CEO Phil Condit, and the board split the jobs of CEO and chairman, naming Harry Stonecipher CEO and naming Lewis Platt as chairman
But what about the board itself as a source of the companys problems?
Stonecipher isnt exactly an outsider. He was Boeings chief operating officer from 1997 through 2001 and has been a member of the Boeing board since 1997. In addition, as CEO of defense contractor McDonnell Douglas before it was purchased by Boeing, hes steeped in the defense industry culture that may be precisely Boeings problem now. That culture is, in fact, heavily represented on the board by directors such as John McDonnell and retired chairman of the U.S. Joint Chiefs of Staff John Shalikashvili. The saying is that a fish rots from the head. At Boeing, is that head -- a board of directors that just isnt up to its job -- still in place?
Motorola: A do-nothing board wakes up but does too little. Motorola is another example of a do-nothing board that finally woke up but then didnt do enough to fix the problem. In 2004, the board brought in Ed Zander, a 15-year veteran of Sun Microsystems (SUNW, news, msgs) and president of that company from 1998 through 2002.
In my opinion, Zander is a clear improvement over outgoing CEO and chairman Chris Galvin who presided over Motorolas decline in the late 1990s. Galvins main claim to the job was always his membership in the family that founded Motorola.
But once again, this board has missed the boat. Motorolas problem is that it continues to see itself as an engineering company in markets that are now dominated by design and marketing. In wireless phones, the company is a fading No. 3 in an industry that it invented. Hiring Zander, a superb operations guy at Sun, a superb engineering company, hardly seems the way to set the company on a new direction. In fact you might read it as an endorsement by the board of the companys past direction as long as Zander does it better. But then what do you really expect from a board of directors that gave Galvin a $1 million bonus and $4.3 million in restricted stock in 2003 as a sign of a job well done?
Rite Aid: A board that rewards itself first. In 1999, a scheme to inflate executive compensation by manipulating company earnings left Rite Aid on the verge of bankruptcy. Result: The company had to restate $1.6 billion in earnings in 2000.
Out went the whole management team, with most of them on their way to prison. CEO Martin Grass, for example, was sentenced to eight years in jail in May. In came a new team headed by Robert Miller, former chief operating officer of Kroger (KR, news, msgs), and stocked with retailing veterans from grocery chain Fred Meyer.
Id love to report that a company thats been through what Rite Aid has been through has come out of the mess squeaky clean, but Rite Aids score on the Clean Stock checklist is mixed. The company did move to separate the office of chairman and CEO this year, with Miller keeping just the chairmans job and Mary Sammons, a 15-year Fred Meyer veteran, becoming CEO.
But the companys board is light on the kind of high-powered independent directors Id like to see in this situation, and the board has voted itself a rather generous compensation package of the sort that raises warning signs. Each director gets 100,000 options upon election to the board and then 50,000 for each year on the board. I find other worrying signs, such as personal loans from the company to Miller and Sammons and rather hefty grants of 500,000 options each to Miller and Sammons in fiscal 2003. Nothing illegal in any of this, which is certainly an improvement. But it is still not what Id like to see as a shareholder.
It is really hard, apparently, to teach an old company new tricks.
The three nominees from readers for the next Clean Stocks reports are Chicos FAS (CHS, news, msgs), Cincinnati Financial (CINF, news, msgs) and Lennar (LEN, news, msgs).
To nominate a stock for a future Clean Stocks report, just send me an e-mail with the name of the stock and any reasons that you have for thinking it might make the list.
New developments on past columns
Bull market in metals is just beginning
Ah, the ever-changing metals market seems to have shifted direction again. Fears have temporarily abated that China is headed for a hard landing that would slow its economic growth to a crawl and put the countrys appetite for raw materials on a diet. Fact is, however, the prices of metal-mining stocks have started to respond to tight supplies and a weaker U.S. dollar. On June 18, the price of gold rose to $396 per troy ounce, close to the magic $400 level that ignites mass interest in the metal. The price jumped in reaction to the higher than expected U.S. current account deficit of $145 billion announced on June 18.
According to the most recent Goldman Sachs forecast, gold is headed to $420 an ounce this year. Nickel prices soared on the London market, rising 8% on June 17 and another 4% on June 18. Nickel inventories have fallen to lows not seen since 2001. Spot market copper prices have recovered to $1.20 a pound, and Goldman Sachs projects that the metal will sell at that average price for the rest of 2004 and at $1.25 a pound in 2005.
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 shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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