April 24, 2003
Dow Jones Average: 8,440
S&P 500 Index: 911
The Owner's Share
It is widely assumed that in a capitalist system the greatest financial
rewards flow to those who own shares in corporations. While shareholders
have enjoyed a higher rate of return than bondholders or C.D. buyers
over the balance of the past century, the returns have varied greatly
from decade to decade. Stockholders in a corporation share the money
that is left over after all the corporation¹s obligations have
been met. Corporations are obligated to pay suppliers, employees, retiree
benefits, lenders, and taxes, but they are not obligated to pay shareholders
anything. When business conditions are favorable shareholders receive
more than anyone, at other times they receive little or nothing.
Most recent reports from American companies mention healthcare costs,
pension expenses, and energy costs as impediments to profitability.
The underfunding of pensions has become a major problem for companies
that have made commitments to a large base of retirees. In the late
1990¹s the value of company pension plans was propelled by the
rising stock market. Plans became larger than necessary to meet future
obligations to retirees.
Companies counted part of the increased pension value as earnings even
though the money was never available to shareholders. Now that the stock
market has dropped pensions have become underfunded. Companies have
been forced to collectively add billions of dollars of real cash to
plans, undercutting a rebound in earnings. The stock market is supposed
to reflect corporate earnings, but it has now become an influential
factor in determining earnings.
At a time when many companies are struggling to show decent profits,
shareholder value has been reduced and in some cases destroyed by excessive
executive pay and stock option packages. Top executives are hired by
a company¹s board of directors to work for the shareholders who
are the owners of the company. In theory the executives should not receive
big bonuses and stock options unless they engineer a substantial increase
in the long term value of the company. The reality is that executives
have been feeding at the corporate trough, becoming fabulously wealthy
while shareholders have suffered a decrease in returns. High levels
of executive pay cut directly into earnings, while stock option grants
dilute the ownership position of existing shareholders. While the economy
and stock market bubble can be blamed for some of the malaise afflicting
the stock market, the short sighted, self serving actions of corporate
executives have been a major contributor to the decline in profit available
to shareowners. The situation will not improve until shareholders assert
their ownership position and take a more activist role in monitoring
corporate executives.
Current Strategy
The stock market has been waffling back and forth with little net
change for the better part of the last twelve months. Rallies have been
driven by hopes of tax cuts, interest rate reductions and economic improvement,
while declines have been sparked by war, geopolitical tensions, and
fears of the SARS virus. With so many factors in play it is hard to
discern a definitive trend. The legacy of the stock market bubble and
suspicion about the veracity of corporate accounting are perhaps the
biggest deterrents to a sustained market advance.
We have increased our rate of stock purchases since last July for
more aggressive accounts. Our stock selections have covered a wide range
of industries and have included both large and small companies. The
best investments during this time period have been small to mid-size
growth companies that do not have onerous pension liabilities or excessive
stock option plans. Dionex and Hain Foods were two selections that met
our preferred profile. While we spend a lot of time analyzing balance
sheets, price to sales ratios, cash flow and other financial data, our
focus is increasingly on the integrity of corporate management.
Two months ago we made a major sale of bonds, selling the inflation
protected treasury bonds at a substantial long term gain. We concluded
that the fear premium built into the bond price was too high and would
probably lessen as global tensions abated. The bonds have come down
about five percent in value since we sold them. Five percent in a couple
months is a big number in a world where investors are trying to make
a few percent per year in bonds. We are hoping to buy the inflation
protected bonds back if they decline a bit more in price.
