Is Apple a Buy?

Apple (AAPL) stock is trading at an all-time high, as of about midday Friday. No doubt, Apple is a leader in innovation , revolutionizing the way Americans and the world listen to music and communicate on the phone. Earnings are strong and organic growth appears to be experienced in the U.S. and abroad. Does this point to a higher stock price, pushing the all-time record to new highs? Maybe, at least in the near future. Is this stock a buy? Here are three reasons why you should absolutely not buy this stock.

1) Company executives are selling stock.

A million shares of Apple stock were sold by company executives – including the COO and CFO – last Friday, which were restricted shares granted as compensation back in 2005. The restricted shares were not unlocked for sale until this week, and several executives took advantage. This is a signal that those executives do not believe the stock will continue to rise, otherwise they would have wanted to hold onto the shares. While it is possible the execs elected to sell to diversify their investments, minimizing their risk and exposure to Apple performance, the investment community should not neglect this bearish signal.

It may be suggested that the executives sold their restricted shares to have more cash on-hand, and perhaps use it to make some purchases. However, COO Tim Cook received a $5 million bonus two weeks ago; in other words, he is not strapped for cash. It is not out of the question, but don’t bet on it.

2) The iPad sucks.

As Apple enthusiast and blogger Sebastien listed in his post, there are many reasons to hate the iPad, and it certainly let people down who were anxiously awaiting its presentation. Apple and its investors are optimistic on iPad sales, and in addition to its drawbacks, competition in the tablet business – the Microsoft Courier, in particular – are going to hurt iPad sales. As Apple blogger Darrell Etherington wrote, the Courier especially could compete with the iPad. The iPad may sell, but don’t expect good reviews and don’t expect it to meet the expectations of the investment community.

3) Steve Jobs could die soon.

Rumor has it that Steve Jobs is in good health, but he has seemingly impossibly overcome pancreatic cancer. Despite what his doctors and the company have said, his health is still fragile, and he is still very prone to another cancer outbreak or life-threatening illness. It is also not out of the question that Apple has not fully disclosed all the details of Jobs’s health. Jobs rescued Apple from its near bankruptcy and has been driving its innovation ever since. When Steve Jobs dies, Apple stock will fall at least 10%. Can you imagine someone else giving the quarterly Apple keynote presentations? Jobs is the life and blood of that company.

If you got into Apple early, congratulations on your successful investment. Take your gains and cash out. If you are looking to get into Apple now, you are too late. Apple has peaked, and the above reasons are factors that make Apple a risky stock to buy, as well as one likely to fall. Dump it, and cash out…if you have cash to invest, look elsewhere.

TARP - Not the Price It Appears to Be

The Troubled Asset Relief Program (TARP) was enacted by the U.S. Government in 2008 to provide struggling financial firms and key U.S. employers with cash to maintain solvency and avoid bankruptcy. To disburse this cash to the firms, the U.S. Treasury bought shares of preferred stock in the companies, as well as purchased toxic assets, such as mortgage-backed securities, off of the companies’ balance sheet. The total amount allocated to TARP was $700 billion, which is commonly misconceived as the actual price of the program. Many are under the misconception that the $700 billion was a sunk cost – U.S. taxpayer dollars that were spent, added to the U.S. national debt, and will never return. However, the fact of the matter is that in the end, the actual cost of the program will only amount to a fraction of the $700 billion originally budgeted.

The TARP dollars were distributed in the form of a loan or investment in the company being “bailed out,” and the U.S. government distributes those funds under the full expectation that the funds will be repaid and even a certain rate of return will be rewarded. For example, the $45 billion loaned to Bank of America as a part of the TARP program was repaid in late 2009. The $25 billion in preferred shares purchased by the U.S. Treasury in Wells Fargo yielded a $371 million dividend early last month.

Like any loan, some will default and the loaned funds will go unpaid. Of the $700 billion issued, some of the loans or investments will go south and go unpaid resulting in a loss; however, the actual cost of TARP – a fraction of $700 billion – versus the benefit – rescuing the U.S. economy and world financial system – was well worth it. Indeed, the Congressional Budget Office has issued a statement detailing the cost of TARP at $109 billion, a fraction of the original $700 billion. Considering the companies receiving TARP funds can be regarded as “risky” loans or investments, this cost is relatively low.

One’s stance on the bailout and the way the U.S. government has handled it aside, everyone should at minimum be clear as to how the program works, what its goals are, and what the true cost to U.S. taxpayers is. Hopefully this post has been successful in that regard.

Striking Optimal CEO Pay Structure

In light of the recent financial crisis and “Great Recession,” CEO and executive compensation schemes have come under fire by employees, investors, and the United States Government. Businesses and more specifically, financial firms, assumed high levels of leverage and risk, and over the past two years have reported massive and mounting financial losses as a result of poor investment decisions. Yet, amid these losses, company executives and CEOs have still experienced large bonuses and compensation packages, much to the chagrin of shareholders, laid off employees, and even the U.S. government. This has led boards of directors, policymakers, and investors of all types to question how CEO compensation packages should be structured. The focus is currently on c-suite executives at banking and financial institutions, whereas in the past it has been on other types of companies, such as automobile manufacturers, and in the future it will be on another industry experiencing losses with highly paid CEOs. However, while I cannot offer an end-all, be-all answer or a definitive formula to calculate how exactly to compensate CEOs, I will put forth in this paper the optimal pay strategy that will serve the best interests of the company, its employees, and its shareholders. To maximally incentivize and obtain the best possible performance from its CEO, companies should utilize a compensation structure that is cash-based, low salary-high bonus, and involves only a preset salary and no preset bonus figures or benchmarks. Furthermore, total compensation and year-end bonuses should be decided upon by utilizing a high degree of managerial discretion.

To begin the discussion, it is best to take a step back and actually visit what it is exactly a company seeks to extract from its CEO and what it is the CEO demands in return. The CEO oversees the entire operations of a company, putting the final stamp of approval on the company’s major investment and business decisions. These decisions are made with the intention of generating revenue, profit, and ultimately creating value for distribution to company investors, shareholders, and employees. In return, the CEO demands compensation for his or her time, effort, and results, essentially earning a piece of the created value pie. The question of how this piece of the pie should be composed to yield the maximum overall size of the pie is what requires discussion.

Contrary to widespread practice today, compensation packages should be paid in cash, rather than equity. Common equity-based pay devices include shares of stock, stock options, and warrants. The salary and bonus paid to a CEO should be cash-based, where the salary is paid in cash periodically throughout the year, and the bonus is paid in cash at the time the compensation decision is made. Indeed, research shows that companies exhibiting sustained earnings over time tend to compensate their executives more with cash than equity (#1). Nonetheless, in nearly every Fortune 1000 company, CEOs receive a significant portion of their total compensation from equity-based pay. The problems associated with this type of pay structure and the specific case for cash over equity is best made by pointing out of the shortfalls of equity-based pay and the issues they create.

Equity, and more specifically, stock option compensation allows the CEO to personally profit from inside information, which could very well cause outside investors and the company itself to lose. As a CEO accumulates ownership and shares of stock in a firm, he or she will rationally elect to exercise stock options and sell shares of stock to yield the highest possible profit. Typically, this will occur at a point in time when the CEO believes the company’s stock price to be at a high – in other words, the CEO expects poorer performance going forward and wants to cash out while the company is hot. By selling shares or exercising options, the CEO is indirectly communicating his or her expectation of weaker future performance; the investment community picks up on this and reacts by selling shares and taking similar bearish positions on the company’s stock. Studies have shown that large option exercises typically occur after abnormally positive earnings performance, and post-exercise, the company tends to perform more poorly (#7). So in the process, the CEO gains by cashing out at a high point, and shareholders lose by a stock price decline as a result of the large sale of stock by the CEO and the ensuing sell-off by the investment community taking a bearish position.

It can be argued that the above stated problem can be solved by awarding stock options with periodic, set exercise dates. The investment community would then not react negatively to the exercise of the stock options, and the CEO could not take advantage of inside information to sell stock at a high. However, this may cause the CEO to alter his or her strategy for the company and not take on projects or investments it might otherwise take on. As pointed out in a study, managers are more likely to take less risky endeavors for their company in order to preserve the company’s stock price if his or her options are in-the-money, and if their options are out-of-the-money, the manager may be more risk-tolerant in an effort to possibly boost the company stock to an in-the-money range (#9). The CEO should make decisions that are best for the company with personal interests set aside, and stock options with set exercise dates alter this decision-making process.

A final problem that comes with equity-based pay is the increased incentive for the CEO to make financial accounting manipulations – legal or otherwise – to potentially boost the company stock price before he or she exercises stock options. Especially if the CEO expects weaker performance in the future, manipulations to the accounting statements can be made to artificially inflate earnings at present (there are legal ways to do this), which could result in a higher stock price, allowing the CEO to exercise his or her options and maximize personal profit. However, for reasons mentioned earlier, this will cause the company’s shareholders to lose. In addition, it has been proven that poor earnings in post-exercise periods are a result of the reversal of inflated earnings in the pre-exercise period (#7).

Because the two main ways to compensate a CEO are through equity and cash, the information presented thus far against equity-based pay points to cash as the optimal choice. Although the company will need to have the cash on-hand to make payment, it avoids the aforementioned equity-based problems, as well as possible cash flow or stock dilution issues in the future come stock option exercise time. If a CEO truly believes in the performance of the company going forward, he or she can always use the cash compensation to purchase actual shares of the company and obtain the equity that way. The main argument against cash-based compensation is that it does not cause the CEO to have a personal vested interest in positive company performance, as stock ownership would. However, this issue can be side-stepped by implementing a low salary-high bonus pay scheme.

A low salary-high bonus compensation structure involves paying a CEO a salary that is very low relative to the bonus he or she could possibly earn, which will incentivize the CEO to seek optimal company performance. The year-end bonus could end up being as much as five or ten times the CEO’s salary, or even more. The reasoning behind this strategy is that a salary is a fixed, guaranteed amount the CEO will earn, regardless of company performance. No matter how the company performs, the CEO earns that fixed salary. A high salary with low bonus will provide a smaller incentive for the CEO to maximize his or her firm’s performance, because the CEO stands less to gain from improving firm earnings. Shifting compensation from a salary form to bonus form puts the CEO in a position in which his or her compensation is almost entirely based upon company performance, so the CEO will put forth his or her best effort and the most time into making sound strategic investment and growth decisions for the firm.

A problem cited with this type of pay structure is it causes the CEO to place too much emphasis on the current fiscal year performance to get a large cash bonus, rather than a long term growth and performance strategy for the company. As mentioned earlier, riskier projects or certain accounting manipulations could be made in order to boost current-year earnings. This problem is also reason to avoid certain bonus benchmarks, such as a set dollar bonus if some company performance metric (stock price, earnings, revenue growth percentage, etc.) reaches a specific level. Again, the CEO may engage in some clever financial footwork to achieve certain same-year performance levels. That being said, evidence suggests that CEO pay does increase in the short term with unexpectedly good accounting performance, but this later reverses and is followed by lower CEO pay in later years as the company does not perform as well in the future. This same evidence suggests there is a net zero gain in CEO compensation from unexpectedly good accounting performance (#2). While the aforementioned is a problem – at least in the short run – the problem can be averted by implementing a high degree of managerial discretion in the bonus decision-making process.

Managerial discretion as it pertains to compensation can be defined as the ability of managers to use their own opinions and evaluation of performance in determining the compensation of an employee. The goal of managerial discretion is to better link the pay of a CEO to his or her performance and give a fair, earned, and deserved bonus to the CEO. Managerial discretion eliminates the possibility of a CEO receiving a bonus based on short-term above-expected financial performance as a result of accounting manipulations or short-term budget cuts, because directors can recognize the manipulations and limit their influence as a factor in the true evaluation of the CEO’s performance. Indeed, a study found that executive compensation is more closely related to performance when a high degree of managerial discretion exists, as compared to a firm with low managerial discretion (#4). While budget cuts or financial manipulations may serve a purpose and provide some measure of value to the company, company directors want to compensate the CEO and other managers for the true value they create for the company. A high degree of managerial discretion in the pay process can ensure they are compensated for value-adding, long-term activities, rather than short-term fancy financial footwork.

A high degree of managerial discretion in a cash-based low salary, high bonus CEO compensation structure will allow the company to extract as much as possible from its CEO and ensure all of his or her decisions are in the best interest of the company. The optimal medium between what the firm gets from its CEO and what the CEO gets from the firm can be found, maximizing the value created for employees and investors. The incentive issues associated with equity-based pay, such as temptations to make accounting manipulations, take on unnecessary risk, or sacrifice long-term performance for short-term success, are eliminated with cash-based pay. The low salary, high bonus structure compensates for true performance, and the managerial discretion makes sure the performance is both accurate and in the best interest of the company. Yet, today most companies still pay their CEOs primarily with equity and a low degree of managerial oversight. It is still a mystery as to why this is happening, but the solution – or at least, the theoretical solution - with supporting evidence is there.

#1 Executive Compensation and Earnings Persistence. Allan Ashley, Simon Yang.

#2 Accounting and Stock Price Performance in Dynamic CEO Compensation Arrangements. Boschen, Duru, Gordon, Smith.

#4 Bank Performance and Executive Compensation: A Managerial Discretion Perspective. Magnan and St-Onge.

#7 Private Information, Earnings Manipulations, and Executive Stock-Option Exercises. Bartov, Mohanram.

#9 Executive Stock Options: Early Exercise Provisions and Risk-taking Incentives. Brisley.

Investment Banking Analyst – Part 2: Stress

Continuing from the previous discussion of the sleep deprivation effects of being an investment banking analyst, the arguably most detrimental aspect of the job is stress. The stress is generated from a lack of sleep, free time, and opportunity to receive care from others, as well as immense pressure in the workplace to produce error-free work and meet tight deadlines. Stress obviously has a long list of health effects; the most important of which are, arguably, the effects on aging.

As mentioned in Part 1 of this series, sleep deprivation can cause an investment banking analyst to feel as though he or she has physically aged four years in two years’ time. While sleep deprivation plays a major role in this feeling, stress also is a major factor in driving that feeling. Stress can also turn that feeling into a reality – stress has been noted to cause grey hair at an earlier age, or even hair loss at an earlier age. Looking and feeling older are not desired traits by young adults around age 25.

Another fallback of the immense amount of stress placed upon investment banking analysts is they grow used to it and learn to expect stress in their lives. That is not to say necessarily that analysts learn healthy ways of dealing with stress, however. Stress becomes such a constant and ongoing part of their lives that even in situations without stress, analysts commonly find or create stress to make that situation revert back to “normal” for them. Although younger Americans are typically more stressed on average, investment banking analysts take this to a whole new level as stress becomes an unhealthily expected part of their daily lives.

As touched upon briefly before, stress can cause a change in physical appearance, but it can also take a toll on the overall health of the body’s organs. The normal physical aging and aging in appearance process an individual’s body might go through is severely accelerated by working in investment banking. In addition to looking and feeling older, the body may actually be older at the end of one’s stint as an analyst. Stress can increase the risk of cardiovascular disease and hypertension in the heart, ulcers and other digestive issues, and even skin problems, which would have either not occurred at all or occurred in later life. This accelerated aging and creation of health risks are downsides of the job directly attributable to stress.

Stress in one’s life should decrease as they age. The issues and uncertainty associated with puberty, maturing, finding a job, and starting a family certainly cause stress to be high beginning in the late teens to mid twenties. However, as people grow older, more decisions are set in stone and settlement takes place, thereby reducing uncertainty and the sense of worry. This would lead to stress decreasing as people age, which holds true for Americans. I would also expect this to hold true for investment banking analysts, but due to the high stress in investment banking and analysts being accustomed to stress as part of their lives, I predict analysts maintain a higher level of stress than the average and take longer to begin becoming less stressed. As far as aging is concerned, a lower level of stress for a shorter period of time would appear to be ideal, but in the case of an analyst, he or she would experience the exact opposite.This could lead to serious aging consequences down the line.

In summary of Parts 1 and 2, sleep deprivation and stress are very real aspects of the lives of an investment banking analyst on Wall Street. Both inevitably accompany the job and create serious impacts on the aging process. College students considering entering investment banking should strongly consider these issues before pursuing a career in the field.

Fraternity - Not Just a Social Club

In a recent post on his blog, Stephen Mack discussed “liberty, equality, and fraternity” as being three values most important to Americans, but he claims we only truly care about liberty and in part, fraternity. While Mack is largely correct, Americans care more for fraternity than he gives credit, as fraternity is one of the most important necessities to have life, to have liberty, and to be happy. “Life, liberty, and the pursuit of happiness” is the American Dream, at least in theory, and without fraternity, that dream cannot be recognized.

Money cannot buy happiness, but not having enough money can prevent happiness. Bills coming in and having no money to pay the rent is a very tough experience, and having to go through that on a frequent basis can cause people to be unhappy. However, some individuals who do have this sort of lifestyle have led happy lives, relying on friends and others to provide pleasure in their lives. On the opposite end of the spectrum, money being no object in any decision in life does not promise happiness. People will flock to mooch or pretend to be a friend to get a piece of the dough, but money cannot buy you true friends. Without real connections to friends, family, or other people, true happiness cannot be found, despite what one’s outward appearance may be.

True friends and camaraderie – “fraternity” – can help one find happiness without economic success, but without them, happiness is impossible. So while I agree by and large with Mack’s assertions, he falls slightly short on the fraternity front.