In the world of investing, they call it "key man risk" -- the idea that there are some members of a business team whose presence props up the whole enterprise (and those people certainly don't have to be men). As one Motley Fool Answers listener points out, when Sarah Friar recently left her longtime post as chief financial officer of Square (NYSE:SQ), the stock sank. By contrast, Dave Morton resigned as Tesla's (NASDAQ:TSLA) CFO just a month after his arrival, but the electric-car maker's shares took a hit on that news, too.
In this segment of the podcast, host Alison Southwick is joined by senior analyst Jason Moser and Motley Fool Wealth Management's Ross Anderson to talk about how much these "key people" are worth; whether such stock moves are directly related to their value, or whether they reflect issues of which the departures are only symptoms; and more.
A full transcript follows the video.
This video was recorded on Nov. 27, 2018.
Alison Southwick: The next question comes from Nate. "Two stocks in my portfolio have experienced major losses to their share price: Square and Tesla. Both have had an announcement regarding their CFO leaving and the stocks had 10-15% losses the next day, which may translate into the departure of a single employee who was able to contribute 1,700 to 2,400 hours per year to their jobs makes the company's market value decrease by approximately $3.4 billion or more." Those are valuable employees.
"How much should a reasonably Foolish investor value a specific executive on a board of a publicly traded company? How should a company's compensation plan for a specific executive change in order to ensure they compensate for the value they apparently deliver to the company." Emphasis mine.
Jason Moser: Very good question because it compares two very different companies and I own shares in one and I don't own shares in the other.
Southwick: Yes, I have Square.
Moser: I own shares in Square. I do not own shares in Tesla. Now I like that Nate went through and did the math, here, and I appreciate it. Now let's also remember that this all doesn't just fall back to the departure of a CFO. At the end of the day you've still got two companies, here, neither of which is profitable, so Wall Street is going to be a little bit more nitpicky with these types of companies in the short run until they build demonstrable, sustainable, profitable business models.
So with all that said, Nate, if a 10-15% loss is major in your book, then you may need to diversify because really, in all honesty, that isn't major. That's pretty much part and parcel with investing in stocks. Twenty to 30% is not major. Major is probably a haircut at 50% or more and, as Ross mentioned earlier [as to whether] 50% alters your timeline or strategy; that, I think, is where major starts coming to play here.
Now if we look to how valuable one person is to any given business, it is definitely going to vary from business to business. I would argue, in Tesla's case, that the CFO for Tesla is not as valuable as you probably would think. I think the key to Tesla is Elon Musk. If Elon Musk disappears from the picture, they're in big trouble, and I think one of the big reasons is because he's the one who's grown this business from where it was to where it is today and if you see, he's out there day in and day out either on Twitter or in the press really pushing that message. He needs to keep that stock price in a certain range. He knows it because this is a company that relies a lot on debt to be able to fund the business and keep growing, because they're not profitable, like we said. So for me, the CFO loss with Tesla not nearly as big of an issue.
Now with Square, I found the departure of Sarah Friar to be disappointing and not terribly surprising, because she's extremely talented. In Square's case, this is a company that's sharing a CEO. Jack Dorsey is the CEO of Square and he's also the CEO of Twitter. He's been criticized for that, but the fact of the matter is both businesses are performing rather well. But my point is that Sarah Friar really was more than a CFO. She was the most public-facing executive for this company. I would venture to guess she probably knows more about the business than Jack Dorsey does to be honest with you. And that's not an insult to Jack. I think it's a testament to how strong of an executive Sarah Friar is. So for me, to see Sarah Friar leave -- I really do hope that Jack is able to bring someone in who's as aware of the business and the market opportunity that exists.
Now, when it comes to compensation, it's another subject we could probably drone on for about an hour and most people don't want to hear it, but it is something where it's going to boil down to opinion. I would say one of the things we tend to do is look at a company's filings to get a better idea of exactly what a company's compensation strategy is. There's a form called the DEF 14A that gives you all of the elements of executive compensation. And if you look at Square, for example, it's very interesting [to see] Jack Dorsey's compensation in regard to Square as CEO. His base salary. I'm going to give you a guess, here. How much do you think Jack Dorsey's base salary in fiscal year 2017 was at Square?
Ross Anderson: Did he go Buffett it? Like a dollar?
Southwick: He either went a dollar or...
Anderson: I'm assuming it's a low number.
Moser: It's $2.75. And he's basically saying, "Listen..."
Anderson: I didn't mean to ruin the punchline.
Moser: "I've bought into this business. I own a substantial amount of the stock in this company. I'm not worried about the salary. I'm more worried about the long-term success."
Southwick: He's not in it for the paycheck.
Moser: And Elon Musk owns a big slug of Tesla, too. So I like to see executives bought in like that. Sarah Friar -- her salary was structured a little bit differently because she didn't have the same skin in the game as Dorsey, but it's all to say that when it comes to executive compensation, we like to see a healthy mix of salary. Of ownership. Reasonable bonuses based on achievable benchmarks that matter more to shareholders. Things like operating income over net income. Go for those metrics that can obscure the financials less and not more. Those are the kinds of things we look for when it comes to compensation.
Anderson: But when you look at a high-level executive leaving like that, is the reason the market's reacting to it more because it's a symptom? I mean, there's a lot of reasons a person may be leaving a job, [including] if the company is suffering and maybe it's not as publicly known. I'm not saying anything about either of those companies, but is that why the market is going to have a stronger reaction when it's a C-level person?
Moser: I think that's a fair assumption. I think with Sara Friar it's less a symptom because we know that her ultimate goal is to become a CEO and she, indeed, is leaving this job to take a CEO role. Tesla's CFO departing -- a little bit more nebulous. Not terribly transparent as to what exactly is going on there.
Southwick: I think we can guess that Tesla's not an easy place to work.
Moser: And look at another company like Snap, for example, or even Twitter in its early days. When the business was just in shambles, no one really knew what was going on. It was like a revolving door. People didn't want to stick around because they didn't really know what the vision was. So I think it's really all back to making sure you have a leader, there, a CEO, who's able to give people that confidence; that feeling that there is some sort of a long-term vision and understanding how they're going to get there. Every company is a little bit different, but you definitely have to suss that out to get a better idea as to whether it's a company you want to be owning or not.
Anderson: The beatings will continue until morale improves.