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How Much Should CEO Pay Factor Into an Investment Thesis?

By Motley Fool Staff - Dec 5, 2018 at 10:46AM

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If management's compensation packages are outsize, it can be a warning sign.

The gap between the folks at the top of the corporate pyramid and the rest of us has grown remarkably in the past few decades. Consider that as of 2016, the average U.S. CEO earned 271 times as much as the average worker, and that CEO compensation from 1978 to 2016 rose more than tenfold. But even beyond that, there are outliers -- top execs bringing in eight figures...or more. Against that backdrop, it's understandable that one MarketFoolery listener was left wondering how CEO pay ought to affect his analysis of stocks for his portfolio.

In this podcast segment, host Chris Hill and senior analyst Jason Moser talk about how not just pay, but various incentives for (and sacrifices by) CEOs factor into their investment decisions.

A full transcript follows the video.

This video was recorded on Dec. 3, 2018.

Chris Hill: Question from Ed, who writes, "I saw an article written by Dan Kline about 30 CEOs making more than $30 million a year. It got me thinking. When analyzing a company and putting together your investment thesis, how much consideration do you put into CEO pay? Thanks for all the insight, love the podcast." Thank you, Ed, for the kind comment and for listening. Good question. You go first. How much does that factor into your investment thesis?

Jason Moser: It's not something on its own that determines the ultimate action to be taken, but it matters. It can tell you a lot about the individual running the company. With that in mind, it can be squishy. You have to figure, how old is the company? How long has it been a publicly traded company? Is there a track record? What are the types of things that incentive bonuses are based on? Under Armour is a good example. A project I did a number of years ago here at The Fool, looking at Under Armour and the incentive bonus program that they had, what were the metrics that that incentive bonus was based on. And it was net revenue growth, operating income as a percentage of revenue, and inventory turn. And to me, those were very relevant metrics. They tell you the business is growing. They can't really be manipulated too much. It was nice to see something like that.

There is a form that investors can look at to get a better idea of exactly how executive compensation is laid out there. If you look at the table of contents of the schedule 14-A, and that's an SEC form. If you go to EDGAR, you can pull up the 14-A. There's a table of contents entry there for executive compensation. You can read through that to get a better idea of who's making what and how all of that is determined. I like, further, to look for companies where executives have big ownership stakes. I always make sure to tell people, that's not something that determines yes or no, but it does tell you exactly where their interests lie. If someone owns a lot of the company, then that's a lot of incentive to make sure it's performing well. But, it's not always necessarily a good indicator. You can look at Amazon as a mature company, and Snap, we can pick on Snap a little bit here. Even though it's still brand new, the fact of the matter is, when Snap went public, co-founder Evan Spiegel got somewhere around $600 million for a CEO award which was based on just taking the company public. Nothing more than just IPO-ing! Now, we could argue that Snap isn't even worth $600 million at this point. The market's telling you it is, but hey, let's be clear, the math ain't really making sense here yet.

Hill: I don't think you and I would technically argue about that.

Moser: No, I don't think we would. Maybe a listener or two would. But, this goes back to understanding a little bit more about who's steering the ship there. And I look at that, and I just think, wow. That's really taking a lot of credit for something you haven't done yet. Just taking a company public... I'm not saying that's not significant. It is. But for an executive to make the kind of money that Evan Spiegel is making, there's a lot of success already implied there, and he's come nowhere close to proving that out.

You flip the coin over there, and Jeff Bezos, obviously, over time, has really proven out there. And his salary is actually extremely modest. I mean, extremely modest. Now, he owns almost 20% of Amazon, so he's got that going for him, too.

Hill: Which is nice.

Moser: It's squishy, but those are the types of things you want to look at. It definitely matters.

Moser: I would say for me, it's on the checklist. It's not high on the checklist, but it is one of those things that I like to see. I tend to look more at not just the straight up salary, but the combined, what is the salary, what is the ownership.

One other thing, particularly if you're buying shares of a more mature company, and this is one of those things that I don't think shows up in official SEC filings, but companies sometimes will announce this, sometimes you'll see CEOs selling shares. And it's not really put out there in any big way that they're on a schedule. For a very long time, this was the case with Bill Gates. Steve Case in the heydays of AOL was doing this, as well. And people would say, "Oh, Steve Case is selling shares of AOL!" Well, he set that up as, I guess the exact opposite of direct deposit. It's just automatic selling. That's just one more thing once you own shares. It's definitely something to look at. To your point, it really does speak to the overall ethos and culture of how the company views compensation, or certainly how the management does.

Moser: I'm glad you brought that up. Another example I like to look at, this was a fascinating story as Twitter's IPO and existence as a publicly traded company evolved over time. Obviously, there were some leadership issues there. Jack Dorsey came back a few years ago to try to help right things. These are the kinds of things that tell you a little bit more about the kind of person that you're dealing with in the executive suite. I mean, he gave a third of his Twitter stock -- which was essentially 1% of the company -- back to the employee bonus pool like. That was stock that he was able to basically give back to the company in order for the company to then be able to attract new talent, without having to go dilute the shareholder base again. He was basically saying, "I own a big chunk of this company already. I'm going to give a little bit of what I have here, knowing that this is a long-term bet on bringing good talent here, and ultimately we're going to be successful and be a lot bigger than we already are." That was a fairly selfless act on his part, I thought. I think his actions with Twitter and Square tell you a lot about the kind of person he is. I think he's a good person.

You can look at those little times throughout their existence as executives to get a better idea of the kind of people that they are. Jeff Bezos, same kind of thing. His history is littered with being able to give that money away to good causes. And we have more seasoned leaders who are coming to the tail end of their careers. Warren Buffett, Bill Gates, whoever. They're talking about making sure they give all of their money away. I think that's really respectable, too. You see those types of things, they can help you understand a bit more what kind of person you're dealing with.

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