Do Nardelli’s Actions Warrant Selling Home Depot?

Home Depot’s recent annual meeting went pretty horribly if you are a shareholder. For CEO Bob Nardelli, it probably went pretty well. He refused to answer any questions, didn’t reveal the results of the shareholder votes, and after 30 minutes he bolted for his private jet. None of the other board members were there because Nardelli told them to stay home.

Now I don’t own Home Depot stock personally, or for my clients, but a lot of people do. Should investors sell the stock after these recent developments? After reading about how Nardelli ran the meeting, I want to say “yes.” However, the stock is pretty darn cheap. That doesn’t mean I would give it a ringing endorsement. After all, Nardelli’s recent actions sure do smell of guilt (of what exactly, I’m not sure, maybe excessive pay, maybe just embarrassment). Trading at 11 times fiscal 2007 earnings, HD shares seem to have limited downside from their current $37 quote.

Share price valuation aside, should his excessive compensation scare investors off? To me, this issue is very difficult. Is Nardelli worth $120 million over 5 years? Of course not. But is Alex Rodriguez worth $250 million over 10 years? Doubtful. These two men are essentially being paid the same amount to do their jobs and the average American finds compensation like this to be completely unfair.

In the baseball world, salaries are determined by what the market will bear. Since fans are willing to pay money to see athletes play, paying them high salaries can actually result in the team earning a profit, so the high salary is “worth it” to the team owner. It’s the market-based economy. It’s capitalism.

Is A-Rod’s job more important than a school teachers’ job? Not at all. However, there are many more people who can teach than can play all-star caliber third base, and nobody is willing to pay $50 to watch someone teach a math class for three hours.

Now I’m not saying A-Rod deserves $25 million and I’m not saying that school teachers don’t deserve to earn more money. But, since how much someone makes is not up to me, I have to simply understand why the system is working the way it is.

As for executive compensation, it is a much more difficult issue to tackle. How much is Bob Nardelli worth to Home Depot? I have no idea how we can begin to figure this out. Therefore, I have no idea how much CEO pay is fair. Are chief executives in this country overpaid? Absolutely. But what is the right number? I just don’t know.

I can tell you one thing, though. In my opinion, stock price performance should not be the only determinant of executive compensation levels. Many are saying that the fact that Home Depot stock has fallen since Nardelli took over in late 2000 proves that he is overpaid. I have to take issue with this.

In Nardelli’s first five full years as CEO, it is true that the stock fell 8%, from $43.88 on 01/01/01 to $40.33 on 12/31/05. However, such poor performance is Nardelli’s fault. Sales during those five years rose 52% to $81.5 billion. Net income and earnings per share fared even better, rising 93% and 111%, respectively.

The poor performance of HD stock is simply due to the fact that the stock was overvalued in 2001, trading at 34 times forward earnings. Investors who bought shares then and lost 8% over the subsequent five years have nobody to blame for that except themselves.

All in all, Bob Nardelli has done a very good job running Home Depot. The only problem is, we really don’t know how much that is worth to the company’s shareholders in terms of compensation. All we know is that $120 million sounds like a lot when the median family is America earned less than 1/500th of that amount during the same period.

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2 Thoughts on “Do Nardelli’s Actions Warrant Selling Home Depot?

  1. Motts McGregor on June 6, 2006 at 8:10 AM said:

    Very good post. This is a huge issue. If I were a shareholder, I would expect the managers to act with integrity and to run the Company in partnership with us. The behavior at the HD board meeting speaks to a lack of integrity and a lack of partnership mentality. Sell. Period.

    Now as for the A-Rod comparisons, this gets into societal fairness issues and I agree this is a unresolvable mine-field. But I don’t think the comparison is all that apt anyway. The difference comes down to this: George Steinbrenner and his minority partners are the ones paying A-Rod. If I were a shareholder in the Yankees I might have an opinion that might be heeded about that but otherwise no. I am just a customer going to the Stadium or watching the game on TV.

    At the Berkshire Hathaway meeting last month — talk about integrity and running the company in partnership with shareholders! — one of the first and best questions Warren Buffett was asked went as follows:

    Q: How should you design compensation plans for cyclical industries.

    And here is his answer (choice quotes noted; the rest paraphrased)

    A (Buffett): “You can coin money in the copper business right now even if you’re the village idiot.” He would measure results more by the cost of production than price; focus on what is TRULY under the control of management. At GEICO for example, they measure 1> growth and 2> the profitability of SEASONED business. Would not give oil company executive credit for oil at $70/barrel. Would want to reward those who have lower than average production costs.

    A (Munger): “About half of companies have unfair compensation plans where management gets paid too much…. It is not rocket science; having a system that is complicated and confusing serves the interests of people who want to get paid more than they’re worth.”

    Surely we could think of a few metrics that would measure the business- and industry-specific factors that are largely under the control of Nardelli and his team.


  2. Chad Brand on June 6, 2006 at 8:51 AM said:

    I agree that coming up with good metrics to evaluate manager’s performance, and having them encourage executives to act as owners, is not too difficult a task. It is not easy though when many CEOs don’t own a large chunk of their stock. And I don’t consider $5 strike price options with a $50 share price to represent true ownership. Of course, even if we got to a point where every manager acted like an owner and was judged on relevant metrics, I still think you’d have people crying “excessive compensation.” So you exceeded your peer group this year. How much does that entitle you to? $5M? $10M? $20M? It’s a tough issue and one that I don’t think will be reasonably solved anytime soon, as long as boards of directors are pretty much hand picked and don’t seem to have to answer to anybody.

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