Shareholders are the ultimate owners of any publicly traded business.
By putting capital on the line to gain fractional ownership in a company, shareholders will participate in the successes (and failures) of the underlying business.
Company management has some very obvious goals that are dictated by shareholders, including:
- Maximize profits
- Minimize expenses
- Reduce reputational risk
- Make ethical and socially responsible decision
There are also certain behaviors that are considered shareholder-friendly, which typically include dividend payments and share repurchases.
Click here to download a free checklist of the characteristics of a shareholder-friendly stock that can be used when screening companies for investment.
This article will discuss 6 signs of a shareholder friendly stock in detail.
Shareholder Friendly Stock Sign #1: Reasonable Levels of Executive Compensation
Executive compensation is a hot topic on both Main Street and Wall Street.
The CEOs of large corporations are almost always the highest-paid employees, and total compensation can reach the $20 million+ range.
Further, CEO compensation has been growing more quickly than the rest of the 0.1% and the stock market (as measured by the S&P 500).
Source: Economic Policy Institute
There are two measures by which the shareholder-friendliness of a company’s executive compensation program can be checked.
First, the total compensation package of a business’ upper-level management should be in the same range as its peers.
Information about executive compensation is disclosed in a filing called the ‘Definitive 14A proxy statement’ with the U.S. Securities and Exchange Commission (SEC).
You can find company filings with the SEC by searching this database. For information on executive compensation, search for ‘DEF 14A’ filings, which will return the company’s ‘Other definitive proxy statements’.
For an example, you can see Johnson & Johnson’s CEO compensation package below.
Source: Johnson & Johnson Proxy Circular
Another important consideration is whether executive compensation is dependent on the performance of the business that they lead.
In most cases, this is certainly the case. CEO compensation is usually dependent on the company meeting certain financial performance targets.
These targets are outlined in the same DEF 14A filings with the SEC. Johnson & Johnson’s criteria for their executive compensation package can be seen below.
Source: Johnson & Johnson Proxy Circular
For investors looking to own shareholder-friendly companies, finding businesses whose executive compensation practices are reasonable and dependent on company performance is a great place to start.
Shareholder Friendly Stock Sign #2: High Levels of Insider Ownership
Insider ownership is when company insiders (executives, board members, etc.) own company stock.
When insider ownership levels are high, this means that company management has a lot of faith in the business’ investment prospects.
Since company management knows more about the business than any investor, shareholders can rest assured that the most-informed individuals are confident in the company’s future.
The requirement of insider ownership is also seen as shareholder-friendly corporate governance.
Details about executive stock ownership requirements can be found in the company’s 14A proxy statements which are filed with the SEC (the same document that holds information about executive compensation).
For instance, Johnson & Johnson’s executive stock ownership requirements can be seen below.
Source: Johnson & Johnson Proxy Statement, page 44
Notice that the stock ownership guidelines are expressed as a multiple of base salary. This is typical among companies who require executives to be shareholders.
A textbook example of high insider ownership is Warren Buffett’s Berkshire Hathaway (BRK.A) (BRK.B).
Berkshire is a large conglomerate with holdings in many industries (including insurance, manufacturing, and railways) that also has a large portfolio of common stock investments.
In Berkshire Hathaway’s 2016 definitive proxy statement, the company reported that Mr. Buffett owned 38.2% of Berkshire Hathaway’s Class A stock. This high level of insider ownership is almost unheard of in a company as large as Berkshire.
Insider ownership (and the requirement of insider ownership) are both signs of a shareholder-friendly stock.
Shareholder Friendly Stock Sign #3: Clear Communication with Shareholders
Through shareholder presentations and press releases, company managements have plenty of opportunities to communicate with their shareholders.
Companies who make the most of these communication opportunities should be appreciated by their investors. There are two benefits to investing in companies who readily communicate with shareholders:
- We can gain a greater understanding into the underlying business
- We can gain a greater understanding of the business’ prospects
For the first point, there is no better example than Warren Buffett (again).
His shareholder letters often elaborate on Berkshire’s businesses in much more detail than is required by the regulators.
This helps investors understand the intricacies of the $433-billion Berkshire Hathaway.
A great example of a company whose management is clear about the business’ prospects is 3M (MMM). The company is very clear about their long-term goals for business growth:
Source: 3M Investor Presentation, slide 14
The Coca-Cola Company (KO) is another business that is similarly candid about business prospects.
In the company’s presentation at the Consumer Analyst Group of New York (CAGNY) conference, the company provided the following slide on their 2016 outlook.
Source: Coca-Cola 2016 CAGNY Presentation, slide 47
As with most things, financial forecasting is best digested in moderation.Even the wisest company management teams cannot fully predict the future.
Business forecasts that go beyond the realm of reasonable prediction should be considered a red flag by investors.
Warren Buffett has warned against excessive forecasting in the past, writing the following in a letter to shareholders:
“Finally, be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate in a tranquil, no-surprise environment, and earnings simply don’t advance smoothly (except, of course, in the offering books of investment bankers).”
Source: Berkshire Hathaway 2002 Annual Report, page 2
With that in mind, management teams that work to help investors understand their business and its growth prospects (within reason) are a sign of a shareholder-friendly company.
Shareholder Friendly Stock Sign #4: Acceptable Use of Adjusted Financial Metrics
When companies report earnings, they have the option to report ‘adjusted earnings-per-share’, which generally backs out one-time expenses such as:
- Restructuring charges
- Severance packages
- One-time tax liabilities
And other metrics that are perceived to impede comparability to previous fiscal years.
Including adjusted earnings in shareholder reports is completely optional. However, the proportion of companies who include adjusted financial metrics has been rising over time.
Source: Business Insider
Warren Buffett commented on this trend in Berkshire Hathaway’s 2016 Annual Report:
“Too many managements – and the number seems to grow every year – are looking for any means to report, and indeed feature, “adjusted earnings” that are higher than their company’s GAAP earnings. There are many ways for practitioners to perform this legerdemain. Two of their favorites are the omission of “restructuring costs” and “stock-based compensation” as expenses.”
Source: Berkshire Hathaway 2016 Annual Report, page 16
Buffett later elaborates on each of these two ‘favorites’, saying about restructuring costs: