The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [204]
In Jobs’ case, if Apple stock rises by just 5% annually through the beginning of 2010, he will be able to cash in his options for $548.3 million. In other words, even if Apple’s stock earns no better than half the long-term average return of the overall stock market, Jobs will land a half-a-billion dollar windfall.22 Does that align his interests with those of Apple’s shareholders—or malign the trust that Apple’s shareholders have placed in the board of directors?
Reading proxy statements vigilantly, the intelligent owner will vote against any executive compensation plan that uses option grants to turn more than 3% of the company’s shares outstanding over to the managers. And you should veto any plan that does not make option grants contingent on a fair and enduring measure of superior results— say, outperforming the average stock in the same industry for a period of at least five years. No CEO ever deserves to make himself rich if he has produced poor results for you.
A Final Thought
Let’s go back to Graham’s suggestion that every company’s independent board members should have to report to the shareholders in writing on whether the business is properly managed on behalf of its true owners. What if the independent directors also had to justify the company’s policies on dividends and share repurchases? What if they had to describe exactly how they determined that the company’s senior management was not overpaid? And what if every investor became an intelligent owner and actually read that report?
Chapter 20
“Margin of Safety” as the Central Concept of Investment
In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, “This too will pass.”* Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY. This is the thread that runs through all the preceding discussion of investment policy—often explicitly, sometimes in a less direct fashion. Let us try now, briefly, to trace that idea in a connected argument.
All experienced investors recognize that the margin-of-safety concept is essential to the choice of sound bonds and preferred stocks. For example, a railroad should have earned its total fixed charges better than five times (before income tax), taking a period of years, for its bonds to qualify as investment-grade issues. This past ability to earn in excess of interest requirements constitutes the margin of safety that is counted on to protect the investor against loss or discomfiture in the event of some future decline in net income. (The margin above charges may be stated in other ways— for example, in the percentage by which revenues or profits may decline before the balance after interest disappears—but the underlying idea remains the same.)
The bond investor does not expect future average earnings to work out the same as in the past; if he were sure of that, the margin demanded might be small. Nor does he rely to any controlling extent on his judgment as to whether future earnings will be materially better or poorer than in the past, if he did that, he would have to measure his margin in terms of a carefully projected income account, instead of emphasizing the margin shown in the past record. Here the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time.
The margin of safety for bonds may be calculated, alternatively, by comparing the total value of the enterprise with the amount of debt. (A similar calculation may be made for a preferred-stock issue.) If the business owes $10 million and is fairly worth