By Joe Escalada
Extraordinary claims require extraordinary evidence--especially claims about high-level executives. These people have huge PR machines and are able to craft public image out of thin air. As an investor, I cringe at the idea of buying a stock at a premium on the basis of a fabled management team.
Many people do not share my reservations, and I urge them to try to evaluate how much of a premium they are paying for stewardship of fabled CEOs. If you don’t have to pay a premium for celebrity management, then there is no real issue. However, high relative valuations should make you think twice about paying substantially more for the touch of a famous CEO.
Consider Ford (F), General Motors (GM), JPMorgan Chase & Co. (JPM), Intel Corporation (INTC), Wells Fargo & Company (WFC), and Amazon.com Inc. (AMZN). At current prices most valuation metric of these companies look cheap:
Ticker | P/E (ttm) | P/E (forward) | P/S (ttm) | P/B | Dividend Yield |
5.68 | 5.48 | 0.28 | 6.89 | 0 | |
4.42 | 4.74 | 0.22 | 0.99 | 0 | |
6.32 | 5.53 | 1.23 | 0.65 | 3.40% | |
10.17 | 8.97 | 2.34 | 2.34 | 3.90% | |
9.18 | 7.07 | 1.69 | 0.97 | 2.10% | |
98.64 | 69.66 | 2.52 | 13.05 | 0 |
We can model total returns after a three or five year holding after selling the stock at a price to earnings multiple of 13. The investor would be able to sell the stock for a profit only if buyers were willing to pay for the stock at reasonable multiples. If investor sentiment had soured, the investor would either have to hold the stock or take a loss. Dividend yield is assumed to be reinvested into shares of the company.
Earnings growth over the holding period will be taken as the lesser of earnings growth over the last five years and earnings growth projected by analysts for the next five years. Using the smaller of the two will lead to conservative estimates. These growth rates are used to calculate terminal price to earnings ratios, that is, price paid today divided by earnings at the end of the holding period.
3 Years Growth | 5 Years Growth | |||||
Ticker | g (past) | g (future) | Terminal P/E | Annualized Return | Terminal P/E | Annualized Return |
F | 4.71% | 7.55% | 4.95 | 38% | 4.51 | 24% |
GM | 0.00% | 12.37% | 4.42 | 43% | 4.42 | 24% |
JPM | 0.89% | 9.02% | 6.15 | 33% | 6.05 | 21% |
INTC | 22.89% | 11.03% | 7.43 | 25% | 6.03 | 21% |
WFC | -4.41% | 12.00% | 10.51 | 10% | 11.50 | 5% |
AMZN | 44.59% | 27.48% | 47.61 | -35% | 29.30 | -15% |
Let’s compare CEOs and how much of a premium we would have to pay for each:
Mulally became CEO of Ford Motor Co. in 2006. His public image is that of a hard-working CEO with 12 hours of work each day, and a tough negotiator that reduced labor costs from $76/hr to $55/hr. Ford/Mulally are the only major car manufacturer that avoided taking government money in the economic downturn. Prior to his time at Ford, he was an executive at Boeing before assuming his role as Ford.
Valuation metrics show Ford is cheap, and given its growth estimates it only trades at a slight premium to General Motors. Investors looking to play a rebound in the US auto industry should own both. Investors looking to buy leadership on the cheap might consider Ford/Mulally a good play.
The opposite situation is present in the banking sector: There is a premium for the management of Wells Fargo & Company over JPMorgan Chase & Co. How do their CEO’s compare? JPM’s CEO is Jamie Dimon, an executive whose fame and popularity won Institutional Investor’s 2011 CEO of the Year poll. He is a Harvard MBA.
John Stumpf is CEO of Wells Fargo and is a University of Michigan MBA. Both men have multiple decades of experience in banking, though Dimon is more fabled. Fortunately, JPM trades at lower multiples than WFC, which means that you are given a discount for the leadership of the 2011 CEO of the Year.
We can also compare the valuations and leaders of AMZN and INTC. AMZN trades at high multiples that are hard to justify while INTC trades at reasonable valuations. AMZN is led by Jeff Bezos, a Princeton graduate and Time Magazine’s 1999 Person of the Year. Bezos’ interests are aligned with shareholders because he is a large holder of Amazon, and draws a relatively small $84,840 salary as a CEO.
He is much more of a celebrity than INTC’s CEO Paul Otellini, a UC Berkeley MBA. Otellini has demonstrated commitment to shareholder interests by overseeing deep layoffs at Intel in 2006, resulting in a 10% reduction of the workforce. Though both CEOs appear to have their interests aligned with shareholders, Otellini is by no means as famous as Bezos.
Regardless of leadership, I could not recommend AMZN over INTC at current valuations. The premium is just too high. Investors looking to benefit from Jeff Bezos’ leadership should wait for lower multiples.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
