One of the main principles of economics is this: people respond to incentives. As a shareholder, you should know how the people running your business are being incentivized. In other words, are the executives being paid astronomical salaries and overly-generous bonuses regardless of business performance? Or do they have a vested interest in the long-term value of the company?
You want the people running your business to have some skin in the game. And I'm not just talking about a few stock options. Ideally, you want a decent chunk of their net worth tied up in the long-term value of the company through significant stock ownership.
This will tell you whether or not their incentives are truly aligned with yours as a shareholder. When they're making business decisions, are they more concerned about a fat bonus check or the long-term creation of shareholder wealth?
Long-Term Incentives
Executives with a lot of personal wealth tied up in the company are motivated to do what's best for the business over the long-term. They are more likely to forego short-term gains at the expense of long-term value.
Rather than push through a questionable deal, for instance, because of some vague "synergies" that may or may not materialize, owners will consider whether or not real value is being created over the long-term. But an executive who is compensated by hitting quarterly EPS targets will likely push the deal through even though it may be a poor use of capital and destroy value in the long run.
This principal-agent problem is a concept we've all seen before. Think about the kind of service you typically get at a big box retailer compared to the service of a small business owner. Let's be honest, the hourly worker doesn't care whether or not you come back or if you refer friends and family to their store. The business owner does. Why? Because they have a long-term interest.
Do the people on the inside have a vested interest in the long-term value of the company? It's an important item to consider when evaluating a stock to buy.
Here are 4 companies with a large portion of insider ownership:
Kronos Worldwide, Inc. (KRO - Snapshot Report)
Kronos manufactures titanium oxide pigments. TiO2 is a fine white powder used in products like paints, plastics and paper to give them maximum whiteness and opacity. Insiders own more than 80% of the company, most of which is held by Chairman of the Board Harold Simmons. Another good sign: no insider has sold any shares over the last 12 months. In fact, insiders have bought more than $12 million worth of stock in the last year.
MSC Industrial Direct Co., Inc. (MSM - Snapshot Report)
MSC is one of the largest direct marketers of industrial supplies and equipment used primarily in metalworking and maintenance, repair, and operations products. Over the last 10 years, MSC has seen average revenue growth of 9%, average EPS growth of 19%, and steadily rising returns on invested capital. Maybe that has something to do with the fact that insiders own more than 90% of the company.
AmTrust Financial Services, Inc. (AFSI - Snapshot Report)
Amtrust Financial is a property and casualty insurance company specializing in coverage for small- to mid-sized businesses. All executive officers and directors together own more than 60% of the company. Founders George and Michael Karfunkel still serve on the Board of Directors and together with CEO Barry Zyskind, own and control the majority of shares outstanding. It's also worth noting that they do not receive any compensation for serving on the Board of Directors.
Syntel, Inc. (SYNT - Snapshot Report)
Headquartered in Troy, Michigan, Syntel provides Information Technology (IT) and Knowledge Process Outsourcing (KPO) solutions. Revenue has grown at a healthy 12% average clip over the last decade while EPS has grown at a remarkable 30% average rate over the same period. The company also carries no debt. Chairman of the Board Bharat Desai co-founded Syntel in 1980 with his future wife Neerja Sethi, who still serves as Vice President of Corporate Affairs. Together they own more than 62% of the company.
The Bottom Line
When evaluating a stock, it's important to know whether or not the interests of the company's executives are aligned with yours. And when it comes to running a business, nobody cares as much as an owner.
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