When CEOs Are No Friend to Shareholders

A CEO's most important job is to allocate capital. If a CEO seems to get distracted by the potential for self-enrichment, it's difficult, if not impossible, to allocate capital in a way that's in the best interests of shareholders.

At the companies mentioned here, evidence suggests that a reasonable system of controls isn't in place. It could be a clubby board of directors or simply a matter of having the right friends on the executive compensation committee. It doesn't matter. I think these companies are no friends to their shareholders.

E*Trade

With a 5% ownership stake in E*Trade (ET - commentary - Cramer's Take), you'd think that CEO Christos Cotsakos would be satisfied with his $110 million worth of stock and concentrate on building shareholder value.

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But he deserves more -- or at least his friends on E*Trade's compensation committee think so. His take in 2001 was more than $60 million, including a $15 million forgiven loan, millions in free stock (it's a "retention instrument"), repriced options and a fully funded retirement plan. (He's 53 years old.) All that comes despite a poor operating performance at the company last year.

By the way, it's Dr. Cotsakos now. Yes, he earned a Ph.D. in Europe, with travel abroad and the help of researchers, thanks to E*Trade shareholders.

E*Trade lost 12 cents in Thursday's session to close at $6.30, off its 52-week high of $12.64 and far from its $70 level of 1999.

IBM

Shareholders of IBM (IBM - commentary - Cramer's Take), a stock I've flagged as overvalued in several columns, should be more than a bit miffed at the incessant feeding at the trough by Chairman Lou Gerstner. He's already taken well over $600 million in capital from the company for nine years of work, with results that are less than impressive: paltry revenue growth, a weakened balance sheet and earnings achieved by a potent, but transitory combination of overvalued stock buybacks, pension income and accounting manipulation (sales, general and administrative expense reduced by gains).

Shareholders take note: Lou needs more, even after he retires -- millions in pension and consulting income, plus another $10 million in stock next March. Oh, and tack on use of company aircraft, cars, an office, an apartment, financial planning, home security and country club expenses.

IBM gained 65 cents Thursday to end the day at $82.25. Its 52-week high of $126.39 was set on Jan. 9.

Home Depot

Whenever negative news clocks a wonderful company, sending its stock down by a lot -- in this case, more than 40% from its all-time high -- you can be sure that I'll be there looking for opportunity. Assessing whether a stock like Home Depot (HD - commentary - Cramer's Take) is a bargain involves, for me at least, a quantitative valuation analysis as well as a review of the business model, with an emphasis on isolating levers that can be used to create or unlock value.

Home Depot has a simple model that's easy to work with. This retailer has been impressive in generating close to 6% net margins since 1999; from 1992 to 1998, it averaged 5% net margins. But history as well as the performance of its peer group and other retailers all point to a fact of life for this model -- this is it, baby: 6% net margins in retail is the top of the heap. This is life at the pinnacle.

There's a lot that can go wrong here and not enough that can go right. I'd sell Home Depot stock at its current quote. The only lever that I can find to support a rise in Home Depot stock is in the top line. If revenue can increase significantly over the next several years, the current market value of the company might be sustained, making the stock dead money at best.

In Thursday trading, Home Depot slipped 80 cents to close at $40.15, vs. its 52-week high of $52.60 reached Feb. 26.

Now for Some Good News

I get asked a lot about my current favorite stock. While I've made more than 40 picks for RealMoney readers, I don't love them all equally. My favorite frequently changes depending on information from or about a company and on the relative price level of the stock. My current favorite -- the purveyor of hotels in the midmarket, including the AmeriSuites and Wellesley Inns brands -- is one of this year's Top 10 Turnaround Candidates, Prime Hospitality (PDQ - commentary - Cramer's Take).

The Turnaround Pet Pick Prime Hospitality is poised to prosper

I recently completed a comprehensive quantitative study of the hotel industry, looking for additional investment candidates. But Prime Hospitality is still the cheapest of the group, despite a 20% jump since I first highlighted it in November, and it has the strongest balance sheet as well. I think this $550 million company has an excellent chance to become a $1 billion or $2 billion company over the next several years. It closed Thursday at $12.30.

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Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, Alsin and/or ACM was long Prime Hospitality, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, The Turnaround Report.