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April 29, 1999 If you own stocks directly, rather that through a mutual fund, you'll get annual reports in the mail. You may get quarterly reports and other communications as well, but mostly it's the annual report. I find these interesting reading. They can be quite revealing about the company and not always in the ways intended. It is the job of investors to judge the performance of management. It is not the job of management to judge the performance of management. But this bugs the hell out the typical CEO and other officers. They are all alpha males and they don't take kindly to criticism. They want to take their judgement and sell it to you. It's your job as an investor to see through this to the real truth. As a stockholder, I am part owner of the company. The managers and employees of the company, from the CEO on down, are working for me. I like to see them working hard, working smart, and being careful with my money. If you were part owner of a small business, this is what you'd like to see. It's no different with a giant public corporation. Before you even open the annual report, just heft it and get an idea of what it cost to mail it. Then open it up and see how fancy it is. Many are elaborately produced large documents, almost a book, with full color printing by the finest process, fine thick paper, perhaps with elaborate cut outs or fold outs. If you've ever had anything printed, you know this costs a lot - maybe $5 or $10 a piece. Frankly, I don't like this at all. I like to see a company keep a tight rein on spending. But as a practical matter, almost all top companies send out a fancy report, so I can't just eliminate them all. There are differences - some are fancier than others - and this is worth noting. Producing a fancy annual report for the shareholders feels to me like a con man's approach. Rather than concentrate on what good financial results we've had this year, the company is trying to appeal to you on an emotional level - look at what a substantial high class outfit we are. In our role as investors, we are not patrons of the arts here - there are better ways to do that - we are rather part owners of a company getting a report from our employees. The hidden message of the fancy report is "This is a class act here. Who are you to criticize it?" You will usually find one or more pictures of the top officers of the company. It's just pure vanity that they put them in there in the first place. The officers are almost always white males, with a token woman or minority (another story there). Look at their picture and ask yourself: Would I lend this person $5? No? Then why have you lent them $5,000? Are they dressed in fancy Armani suits, elegantly coifed and posed by a fashion photographer? Or are they dressed in off-the-rack suits from Sears, with photos that look like they came from the Department of Motor Vehicles? I think you can tell a lot about a person from seeing these photos. Is your guy a fashion plate or is he a heads down business guy? When it's nine o'clock on a Friday night, is he out on the town, or working late at the office? It's your money, take your pick. There will be a section on executive compensation and employee stock option plans (if any). This is important stuff. You want your managers' interests aligned with your own as a shareholder. It's OK if they make a lot of money if the stock goes up a lot - so will you. It's bad if they make a lot of money whether the stock goes up or down. Most of their compensation should come from stock appreciation and profit sharing, not salary. There is a nasty practice of re-pricing stock options when the stock goes down, e.g. if the CEO has options at a strike price of $80 and the stock drops to $30, they would re-price the options to $30. This is so wrong. Instead of giving the CEO a break, the board should be installing a better one, or at any rate not rewarding the current CEO for poor performance. Other nasty things to watch out for are poison pills and golden parachutes. Poison pills are by-laws that kick into effect in case of a hostile takeover offer and make it all but impossible to happen. Golden parachutes guarantee executives fired after a merger a bundle of cash. They also are activated in the event of a hostile takeover. Interesting term, that. It's only hostile to management, not the shareholders. Usually this happens when the buying company can make better use of the assets than current management. If you are offered a nice premium over current market value for your shares, this is a good thing for you. But the managers could lose their jobs, so they don't like that and try to stop it. They argue that things are going to turn around real soon now - ha! - and that the buying company will reap the benefit. This is bull - if things were looking up, it would be reflected in the stock price already. They argue that they can only get good managers if the managers are protected. This is more bull - above all, you don't want protected managers, you want ones with big incentives to do well. But of course they would like a nice situation where they can't lose. You have to be careful with this kind of thinking. If you buy stock in a company without a poison pill and they vote one in, it's bad for your investment. If you buy stock in a company with a poison pill and they vote it out, that's good for your investment. It's the change of status that matters most. Another thing to check is the board of directors. A strong board is one with outside directors (not employees of the company) who are sharp business people and who will brook no nonsense. The board represents the shareholders and keeps an eye on the CEO and top management. What you don't want is a board filled with the CEO's patsies. You can assume any employee who reports to the CEO is a patsy. These are called inside directors. Sometimes there's a "you scratch my back, I'll scratch yours" kind of thing. Two CEOs serve on each other's board. It takes some work to find this out. Non-business people are suspect as board members. Venture capitalists are usually good board members, unless they make common cause with management to screw over the other investors. Ideal outside directors would be like Bill Gates or Ross Perot. Perot was actually a director of General Motors for awhile. He caused them so much grief with his criticisms and suggestions that they finally bought him out at premium (thereby screwing the other shareholders). GM has just gone downhill since then. I think they've even lost their No. 1 place in US auto sales. It shouldn't have been too hard for shareholders to see that coming. The company should have listened to Perot and been glad to have him. GM is my idea of a company NOT to invest in. I realize I've written over-much about Amazon.com. Nevertheless! The 1998 Amazon.com report just came in the mail. I really like this annual report. It came cheaply printed in black and white, with no photographs at all. There are two cover letters (one reprinted from 1997) from the CEO and the SEC Form 10-K, which has all the financial info. That's it - no bull, or at least not very much. The board of directors consists of five people: Jeff Bezos (founder/CEO), venture capitalist Tom Alberg, famous ace venture capitalist John Doerr of Kleiner Perkins, Patty Stonesifer (ex Microsoft VP) and Scott Cook (founder/CEO of Intuit). Perfect. AMZN may be sky high at $168, but this is my kind of annual report. Just yesterday they reported sharply higher revenue for the quarter, but warned about heavier losses in coming quarters as they expand. The stock dropped twenty five points on the news. I'm buying more. In a later report, I will write about the financial statements themselves and what to make of the numbers. Today's close: Dow 10878, S&P500 1342, NASDAQ 2529 All-time High: Dow 10878, S&P500 1362, NASDAQ 2652 September low: Dow 7539, S&P500 956, NASDAQ 1419 The Dow hit another new high today. It's closing in on 11,000 when less than a month ago we were all cheering 10,000. The bull continues to charge. © Copyright 1999 by Richard Gillmann. All Rights Reserved. |