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has come under fire recently for the lavish bonus paid to Chief Executive Aubrey McClendon. His $112.5 million pay package in 2008 was the largest paid to any S&P 500 CEO and has brought about legal action by
While this compensation package is outrageous, it's not the only factor that should make investors wary of the
Excessive pay on its own usually isn't enough of a reason to rule out a
. However, it's a symptom of an overarching problem that can lead to poor
performance in the long run.
When a company pays large sums of money to executives rather than invest in its operations, it reflects a fundamental breakdown in the relationship between the firm's owners, the shareholders, and the managers hired to generate returns. While the negative effects of poor corporate governance aren't always immediately apparent, studies have shown that firms with strong board leadership tend to outperform their peers.
Oklahoma City-based Chesapeake has risen 38% this year, outpacing the 1.1% return of the S&P 500 Energy Index. However, rising energy prices have lifted all boats, and some of Chesapeake's competitors have delivered even better gains.
, for example, has advanced 45% this year with a stronger return on equity than that of Chesapeake.
At 5.1%, Chesapeake's return on equity is less than a quarter of the industry average of 21%. Bigger firms like
offer returns on equity in excess of 29%.
How can Chesapeake justify a $75 million bonus for McClendon when the company trails its rivals by so much?
While Chesapeake is cheaper than its peers, with a price-to-earnings ratio of 10.4, it's also far less profitable. Sturdier companies like Exxon, Chevron and Schlumberger are also trading for less than 23.6 times earnings, the industry's average.
Chesapeake's first-quarter loss widened to $5.74 billion from $130 million a year earlier because of a massive goodwill impairment charge. But even without that expense, the company is weaker than its competitors.
The energy sector is worth considering now that oil prices have crept back above $70 a barrel, but Chesapeake isn't the best option. It's not a bad company. It's just not the best investment.
TheStreet.com Ratings rates Chesapeake "sell" with a grade of D-plus.
TSC Ratings provides exclusive stock, ETF and mutual fund ratings and commentary based on award-winning, proprietary tools. Its "safety first" approach to investing aims to reduce risk while seeking solid outperformance on a total return basis.
Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level II CFA candidate.