Forget the annuals, read proxies
By Martin Sosnoff
AFTER READING hundreds of annual reports, I am sorry to say that they
were mostly barren and factless, particularly United Technologies'.
There were a few good points: I appreciate IBM indexing its financial
statements by category. Coca-Cola's graphics are perennially colorful
and elegant. I like the way the company puts its annual stock
performance in the snapshot summary right up front.
Even Warren Buffett's essay was muted this year, but he did telescope
one significant point, which is unusual for him. Geico, now wholly owned
by Berkshire Hathaway, and the pacesetter in auto insurance, is going
for share of market, big time, and will give Allstate a run for its
money.
The longest and most boring headman's message came from Randall Tobias
of Eli Lilly. Gillette, whose stock underperformed the S&P 500, tried to
put a good face on the underperformance by comparing itself with the Dow
Jones industrials.
If you're not a security analyst or money manager with a broad knowledge
base covering a range of industries, forget about annuals and
concentrate on the proxy statement. It ain't pretty-it's written in
legalese, and in small type, but that's the point. It contains lots of
stuff the company is required to tell you but would just as soon you did
not notice.
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Half of Microsoft's cash flow is dedicated to countering the dilution
from options.
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First you turn to the graph on five-year returns. The SEC has made this
a prerequisite. It tells you how the stock has performed relative to the
S&P 500 and its peer group. If you're happy with that picture, turn to
the options awards, past and future, and dope out how much you're being
diluted. The financial media focuses on management compensation,
salaries and bonuses, but misses the big picture, which is the
extraordinary escalation in options grants that has rippled out from
Silicon Valley and is now pretty broadly based throughout our corporate
culture.
I do not exaggerate when I say that these options programs are a way for
managements to make themselves rich at stockholders' expense. I don't
mind paying for exceptional performance like that of Harvey Golub at
American Express, who has $72 million in options value in his account. I
do have a problem with John Reed of Citicorp whose 2 million options at
an average grant price of $52.49 are worth more than $200 million. The
banking comeback was not masterminded by Reed but by Alan Greenspan, who
let banks arbitrage money for three years in the early Nineties.
In Silicon Valley the options construct is Hollywoodish. Who owns the
earnings stream, shareholders or the management talent? In the Valley,
it's management by a landslide.
Eckhard Pfeiffer of Compaq has $242 million worth of in-the-money
options. With the DEC deal comes 150 million new options for everyone,
10% of Compaq's market capitalization. The only thing good you can say
about this incremental dilution is there will be no downward repricing
of options.
The defining construct is Microsoft's. Nobody, including Bill Gates,
takes a salary of any consequence, but over the past three years
Microsoft has granted options in excess of 50 million per annum. Last
year 45 million options were exercised, about 4% of outstanding shares.
Insiders own 35% of Microsoft, so if they're willing to dilute
themselves we can assume they're doing the right thing to renew the
talent pool. The problem with this largesse is that it consumes so much
cash flow to keep a lid on dilution. Half of Microsoft's cash flow from
operations is dedicated to share repurchases to counter the dilution
from options.
Qualcomm is the extreme Silicon Valley case. There are 33 million shares
reserved for options, and annual increases are running at a 5 million
clip. This on a 72 million share base. If management uses options to
reduce salary costs, this raises questions about whether reported
earnings are overstated.
I like IBM's model. It issues 1% to 2% in options annually, handily
outperforms its peer group of computer hardware producers and has
reduced outstanding shares 13% since year-end 1995. The IBM annual, one
of just a handful this year that made sense, focuses on strategy and
implementation. Yet another reason my firm still owns a lot of the
stock-which I recommended some time ago.
Martin Sosnoff is chief investment officer of Atalanta/Sosnoff Capital
in New York and author of Silent Investor, Silent Loser. |
