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Here's a simple concept that will help you win in the stock market: Greed kills.
No, not the kind of greed that makes investors pour too much money into hot stocks only to suffer big losses on a surprise reversal.
I'm talking about greed in the corner office.
Many studies and real-life examples show that when the top boss pockets outsized pay and stock-option grants, a company's stock is likely to lag -- or worse.
The underlying idea is simple: Excessive pay is a symptom of a board that's not doing its job of looking out for shareholders. So shareholders lose while the bosses get rich.
Excessive options grants also dilute earnings by spreading them over many more shares. Or they force a company to spend money buying back stock already on the market to offset those options. (Read "How stock options rob shareholders.")
Fortunately for investors, there's now a way to seek profit from this concept without poring over documents trying to figure out whether executives are greedy pigs.
For the first time (as far as I know), there's a fund dedicated to this greed principle. It's called Mirzam Capital Appreciation Fund (MIRZX), and early performance seems to prove the case that it pays to shun greedy execs. Since its inception in August, the fund is up 15%, compared with a decline of about 3.5% for the Standard & Poor's 500 Index ($INX).
2 basic rules
Albert Meyer, a former accounting professor from South Africa now based in Plano, Texas, brings a healthy dose of skepticism to stock analysis. He picks companies for the fund by starting with two basic rules.First, Meyer rejects companies where stock-option grants represent more than 5% of the shares outstanding. He says that because of shortcomings in rules on how to account for options, the true cost to shareholders doesn't come through in reported financial numbers. Overly generous grants are so widespread that this rule eliminates more than 75% of the stocks in the Russell 3000 index ($RHK.X), according to Paul Hodgson of The Corporate Library, which tracks grants as part of its corporate-governance rating system.
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Next, Meyer avoids companies where execs get too much pay. There's no strict cutoff. But he's unlikely ever to hold a company where the boss makes more than $5 million a year. That's about half of the $9.9 million in average compensation that CEOs at S&P 500 companies made in 2007, according to The Corporate Library.
From there, Meyer looks for qualities such as pristine financials, strong cash flow, good profit margins and reasonable dividends in businesses surrounded by some kind of protective moat. He's also a value investor who favors stocks that look cheap.
First-rate results
But wait a second. Whenever I focus this column on companies with highly paid CEOs, I'm told that these pay levels are necessary to attract the top talent. Doesn't Meyer run the risk of winding up with companies run by a bunch of second-rate leaders?"It's a total scam to say, 'If we don't pay these salaries, we won't draw the talent,'" Meyer says. "That's not what I find. The companies we own pay modest salaries, and they do extremely well. They are not suffering because of a lack of high salaries."
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Meyer's track record bears this out. Investments for managed accounts at his Bastiat Capital -- where he also shuns companies with greedy execs -- were up 43.4% from April 30, 2006, through the end of April this year. The S&P 500 was up 5.72% in the same time frame. Meyer's picks for an investment shop called 2nd Opinion Research were up 20.5% annualized between December 2002 and December 2005, compared with annualized gains of 5.67% for the S&P 500.
Continued: A stance backed by research
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