The Owner’s Share – April 2003

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.

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