With over 5,000 publicly traded stocks to choose from, researching a winner can feel more difficult than finding your soul mate. To help you pick from the thousands of potential matches for your portfolio, you should read an annual company filing usually overlooked by investors because of its lack of hard financials: the proxy statement. Let's take a look at Williams Companies' (NYSE: WMB ) most recent proxy as an example.
The proxy statement, also known as the DEF 14A, gives you an up-close look at top management. Think of it as a first date with the board of directors. Specifically, look for:
- How is management compensated and incentivized?
- How much is management personally invested (insider ownership)?
- What experience does the CEO have?
- Who is on the board of directors?
These facts provide you with an impression of whether you should trust Williams' management with your hard-earned cash, and a long-term relationship. And because it is difficult to measure management with one simple ratio to screen, this gives you an edge over the rest of the market.
1. How is management compensated and incentivized?
First, managers' salaries should be reasonable relative to revenue's or profits. You don't want a relationship with a company that spends your money frivolously on pearls and golf outings.
New CEO Alan Armstrong has yet to report his total compensation in his new role, so we will look at former CEO Steven Malcom's pay. In 2010 Malcom socked away $8 million in total compensation, with $1.1 million in base pay. Williams had 2010 sales of $9.6 billion, for a ratio of salary to revenue of 0.011%, and total compensation to revenue of 0.083%. This compares to Southern Union Company (NYSE: SUG ) CEO George Lindemann earning a 2010 base salary of $1 million which is 0.04% of Southern Union's 2010 revenue and total compensation of $7.7 million, which is .309% of total revenue. Just looking for reasonableness, it seems Williams passes.
A majority of the compensation might be outside of the base salary, which is great if the other compensation aligns the CEO closer with stockholders, like stock awards. Just beware that the company is not heavily diluting shares through these large stock awards.
Along with reasonable salaries, the bonus structure should be constructed to maximize shareholders' benefit for the long term. This means giving management goals with metrics that they can control and that are not easily manipulated, like revenue, cash flow, or return on equity. These metrics are better than something like earnings per share, which can be coaxed through creative accounting or stock buybacks.
In Williams' case, management's bonuses depended on "economic value added" or EVA, a registered trademark of Stern Stewart & Co. This is the value created by the company measured by taking operating profits after taxes and then subtracting capital costs. As operating profits could be manipulated by management, the starting point of the EVA calculation could be flawed. But, the overall premise of incentivizing value creation, which eventually rewards shareholders, should excite any long-term investor. And, the compensation committee reviews profits and cash flow to ensure these numbers correspond with the EVA. These seem like healthy practices.
2. How much is management personally invested?
Would you want a relationship with a company that didn't share your interests? Of course not. Referred to as insider ownership, this is one of Fool co-founder Tom Gardner's favorite metrics. Found under the "Security Ownership of Certain Beneficial Owners and Management" or a similar heading, you can get a quick view of how much management has riding on the success of the company.
For Williams and its competitors:
Source: Companies' most recent proxy filings.
Typically, insider ownership higher than 5% is good, but of course it's much more difficult to own 5% of a $20 billion giant like Spectra Energy than a smaller player like $5.4 billion Southern Union. In cases like this, you can compare an executive's holdings to his annual compensation, but we have yet to see what Williams' new CEO, Alan Armstrong, will make. However, Williams' compensation committee actually increased the requirement for the CEO to hold equity six times their base salary up from five times, which signals a hefty personal investment that shows the CEO will hold the same interest as shareholders -- beyond just long walks on the beach.
3. What experience does the CEO have?
This is the small talk section of the proxy statement. For Williams, Armstrong first worked at the company as an engineer in 1986 and rose through the ranks to the top. He has both technical expertise and industry experience through many business cycles. Investors can trust Williams knows a little about the energy industry. This decades-long experience seems to be somewhat of the norm in the energy sector, like Questar's CEO Ronald Jibson, who has worked at Questar for 30 years, and EQT's CEO David Porges, who worked at Exxon for several years before working in energy sector finance and finding his way to EQT's board.
4. Who is on the board of directors?
Like a significant others' friends, the board of directors approves the company's major decisions like distributing dividends. At Williams, there is a balance of financial and industry expertise with a former ConocoPhillips executive, a Patriot Coal chairman, and Monsanto's ex-treasurer.
Overall, Williams' proxy statement showed us a good time. Management seems fairly compensated with a proper bonus structure, the CEO is required to be heavily invested, and both the CEO and board have vast experience.
Now that you are prepared to enter the world of proxy statements to find that one special company, what better stock to use your new moves on than our pick for the top stock pick for 2012. Find out what that stock is in this free report!