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Management Compensation Comparison - Does Your Stock's Management Rewards Itself Excessively

Management Compensation Comparison - Does Your Stock's Management Rewards Itself Excessively

In this management compensation comparison, I compare management's compensation with the compensation paid at other relevant and similar companies. Therefore I look for companies which have the following in common with the company which I am analysing:

  • The companies are all operating in the same industry and sector. (I always try to find companies operating in the same business. That's why I compare a gold focused mining company with another gold focused mining company, not with a metal focused mining company in general.);
  • For the energy and mining sectors specifically: the companies are all operating in the same project development phase: exploration, development or production. (Thus, I always compare a gold focused exploration company with another gold focused exploration company, not with a gold focused production company
  • The companies all have a comparable market cap. (It makes no sense to compare management compensation of a $ 500 million company with a $ 25 million company.)

Then, I make a list in an Excel spreadsheet of the relevant similar companies found. I will include the company which I am analysing in this list too. In this spreadsheet I will add the following data for the management compensation comparison:

Data  Description 
Date  The date on which I conducted my comparison to determine if management's compensation is reasonable.
Company name/ Ticker  The name of the companies who have been determined by me to operate in the same industry and sector and have a comparable market cap, as the company of which I would like to know if management's compensation is reasonable. For energy and mining companies these companies are also operating in the same project development phase.
Industry/ Sector  The industry/ sector in which the companies operate.
Project Development Phase  The project development phase in which the companies find themselves.
Market cap (M)  The market cap of the companies (current share price x number of shares outstanding).
Latest Proxy Circular 

The date on which the latest Proxy Circular was filed.

Applicable Year  The year on which the latest Proxy Circular was applicable to. 
Total NEO's1 Compensation (TNC)  The total amount of management compensation and benefits which have been paid in the comparison period to the company's NEO's (often a fiscal year)
Total Director's Compensation (TDC)  The total amount of management compensation and benefits which have been paid in the comparison period to the company's directors (often a fiscal year) 
Total Management Compensation (TMC)  The total amount of management compensation and benefits which have been paid in the comparison period to the company's NEO's and directors combined (often a fiscal year) 
Total Current Assets (TCA)  The total amount of current assets mentioned on the balance sheet at the time of the comparison period.
Total Current Liabilities (TCL)  The total amount of current liabilities mentioned on the balance sheet at the time of the comparison period.
Net Current Assets (TCA - TCL)  Total Current assets (TCA) minus Total Current Liabilities (TCL)

After I finish filling this Excel spreadsheet, I will calculate the following revealing ratio's which help me to determine if the management compensation is reasonable:

1. Total Compensation Market cap Ratio (TMC / M)

The outcome of this ratio is calculated by dividing the Total Management Compensation (TMC) by the Market cap (M). This ratio helps me to determine if the management compensation of the company I am considering to add to my stock portfolio is reasonable compared to the companies I have determined as relevant and similar. As an extra comparison tool, you can calculate the average Total Compensation Market cap Ratio and compare the outcome of the company you are interested in with the other companies which I have determined as relevant and similar.

The lower the outcome of this ratio, the better, although I believe it's reasonable when the outcome of this ratio is around the average. I rate an outcome around average as "Reasonable", above average as "Excessive" and below average as "Attractive" (for an investor's point of view).

2. Net Current Assets Total Compensation Ratio ((TCA - TCL) / TMC)

The outcome of this ratio is calculated by dividing the Net Current Assets (NCA) by the Total Management Compensation (TMC). This ratio provides me with an indication of how many 'comparison periods' it will take before the company I am considering to add to my stock portfolio has spent all their net current assets on management compensation and benefits. Of course, you have to take into account that the outcome of this ratio only provides an insight on a certain moment (the comparison period), but it still can be a very helpful ratio to determine if management compensation is reasonable. As an extra comparison tool, you can calculate the average Net Current Assets Total Compensation Ratio and compare the outcome of the company you are interested in with the other companies which I have determined as relevant and similar.

The higher the outcome of this ratio, the better, although I believe it's reasonable when the outcome of this ratio is around the average. I rate an outcome around average as "Reasonable", above average as "Attractive" (for an investor's point of view) and below average as "Excessive".

Expanding the Scope of the Management Compensation Comparison

If you would like to expand your management compensation comparison, you could easily add the following data in your Excel spreadsheet to do so:

Data  Description 
Total CEO Compensation (TCEOC) 

The total amount of management compensation and benefits which have been paid in the comparison period to the company's CEO (often a fiscal year) 

Total CFO Compensation (TCFOC) 

The total amount of management compensation and benefits which have been paid in the comparison period to the company's CFO (often a fiscal year). 

With this extra data you can easily adjust the two ratio's described above so that you can calculate the Total CEO Compensation Market cap Ratio and the Net Current Assets Total CEO Compensation Ratio by exchanging the Total Management Compensation (TMC) for the Total CEO Compensation (TCEOC). Ofcourse, these ratio's can now also be calculated for the CFO.

To find out how I use these ratio's in practice, I refer you to the note at the bottom of this page.

 

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Note: When I must conclude - based on the outcome of the ratio's described in this article - that management's compensation is relatively high compared to the relevant and similar company's found, I always first check the company's insider stock ownership. The worst combination you can find is a company with a relatively high management compensation and a relatively low amount of insider stock ownership: I will not invest in company's with these traits and I recommend you to be very careful with these companies too! If the insider stock ownership is at an acceptable level, but management's compensation is relatively high, I always contact the management by email to ask them why management is being rewarded so relatively generous. What has management done - compared to the companies used in the benchmark - to justify the height of the compensation paid? Is management aware of - what seems to be - this relatively high level of compensation? Will the company consider adjusting the amount of compensation paid for the near future? If so, with what amount and within which time frame? Depending on the answers I receive, I decide if I need to act on it. As long as management can - and is willing too - justify the reasons for the relatively high compensation, I normally don't see any problems to invest in this company. In this case I will just proceed my due diligence regarding that specific stock.

 

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1 “Named Executive Officer” or “NEO” means the following individuals: (a) each Chief Executive Officer of the Company (or person acting in a similar capacity) during the most recently completed financial year of the Company; (b) each Chief Financial Officer of the Company (or person acting in a similar capacity) during the most recently completed financial year of the Company; (c) each of the Company’s three most highly compensated executive officers (or persons acting in a similar capacity), other than the Chief Executive Officer and Chief Financial Officer, at the end of the most recently completed financial year of the Company; and (d) any additional individual who would be a Named Executive Officer under (c) but for the fact that the individual was not serving as an executive officer of the Company, nor acting in a similar capacity, as at the end of the most recently completed financial year.

About Jeroen Snoeks

Jeroen Snoeks - UndervaluedEquity.com

Jeroen Snoeks is the founder of UndervaluedEquity.com, a website for investors passionate about investing in undervalued stocks. Through UndervaluedEquity.com, he shares his experience and knowledge and will soon reveal his personal stock portfolio.


 
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