It's Time to Build a List of Trustworthy Stocks

I expect that readers will suggest other standards to use in defining clean companies and other places to look for danger signs. And I'll add any good suggestions to the list that I'll append to my next progress report.

Three Clean Stocks to Start

Let me kick off our list with three nominees for the registry of clean companies.

Compensation at Rochester, N.Y.-based Paychex (PAYX Quote) is reasonable and actually tied to performance. For example, no bonuses were awarded in 2002. And the company, which doesn't award any options to CEO Tom Golisano, doesn't seem to have succumbed to options-grant fever. Financial accounting is clean and free of one-time charges, although I don't like the fact that auditor Ernst & Young received about $300,000 for auditing services and $2 million in nonauditing fees.

The board's audit committee, on the other hand, seems solidly independent and experienced. The only outside entity that I was able to find in the financial footnotes are some investments in low-income housing partnerships that don't seem significant to the company's financial picture. The company has adopted new accounting standards on goodwill and did not show any goodwill on its balance sheet at the end of the last fiscal year.

CEO Golisano is deeply involved in New York politics, and he recently bought the Buffalo Sabres hockey team (from the ruins of Adelphia Communications). These outside interests, however, don't put him in conflict with the interests of shareholders. It helps, too, that Golisano owns 10% of Paychex and is worth around $1.1 billion. Earnings growth has dropped to 10% with the weak economy, but analysts estimate that the company will recover to a 15% annual rate beginning in the fiscal year that starts in May 2005.

Northern Trust (NTRS Quote) promotes its managers from within: CEO William Osborn is a 30-year veteran of the Chicago-based banking company. That assures the continuity of values and strategy, but it can create a clubby atmosphere ripe for abuse. Fortunately, Northern Trust's very independent board seems to have this situation in hand. In April 2002 the company replaced its accountant Arthur Andersen with KMPG. CEO Osborn is well, but not extravagantly, compensated by banking standards: $950,000 and a bonus of $1 million. The bonus was less than the maximum allowed under corporate guidelines.

In addition, Osborn received options on 135,000 shares, a big hunk but down from the 150,000 received in 2001 and the 170,000 in 2000. Like the financials of all banks, those of Northern Trust include items for derivatives and various swaps and hedges that can make getting a true picture of the bank's finances difficult. But I didn't see anything here that flashed a danger sign. Much of Northern Trust's revenue comes from its trust-management division; it has some $1.6 trillion in assets under its custody. After falling this year, projected earnings per share will grow by 18% in 2004 and an annualized rate of 11% for the next five years.