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Do Nardelli's Actions Warrant Selling Home Depot?

June 6, 2006 Chad Brand, Peridot Capital Management LLC
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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.

In retail stores
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Peridot Capital Management LLC is a registered investment advisor in the states of Maryland, Pennsylvania, and Washington. The firm may not transact business in states where it is not registered or exempted from registration. In most states, the firm is exempt from registration if it has fewer than six clients who are residents of that state. As a result, Peridot Capital Management LLC is free to provide services to residents of every state and applies for registration as required. Individualized responses to persons that involve either the effecting of transactions in securities, or the rendering of personalized investment advice for compensation, will not be made without registration or exemption.

The content published on our blog represents the opinions of Mr. Brand and he and/or his clients may hold positions in securities discussed. Such positions will be disclosed at the time of publication, although subsequent changes to those positions will be made without notification. The information contained in blog posts is believed to be accurate when published, however, mistakes could be made. As a result, do not rely on the content exclusively for your investment due diligence. The commentaries published do not constitute investment advice, as readers’ personal investment goals and risk tolerances will dictate which investments are appropriate for them. Our blog is meant to be one of many sources for readers to conduct their own research into specific investments. Consult an investment professional before acting solely on information found on this site. If you do not have an investment professional to work with, you may contact Peridot Capital Management LLC directly.