Fat-Cat Stocks Spelling T-R-O-U-B-L-E

Today I am going to reveal to YOU one way our experts at the Motley Fool try to avoid stocks spelling T-R-O-U-B-L-E.

What’s more, this ability to spot danger is something ordinary investors such as you and I can achieve, too.

I mean, there is no complicated maths formula, intricate charting strategy, covert City source or ancient back-testing data involved.

In fact, our experts don’t even have to pay a penny for the information they look at.

They simply study annual reports.

Please do NOT stop reading now – annual reports can protect your wealth!

True, company annual reports can often make the test card look like a Hollywood action movie.

They carry reams of dull text about the business and contain stacks of accounting numbers…

…but they can also contain clues signalling potential problems are on the way.

Too much in the way of liabilities? Dubious acquisition bookkeeping? Legal disputes hidden away in the small print?

Read the annual report closely and you and I could find all of these nasties…

…while the mainstream press, amateur bloggers and bulletin-board hoards just skim the headlines and lap up the PR guff.

There could be juicy revelations within the banking sector…

Believe it or not, annual reports have just become a lot more exciting.

You see, new rules this year mean even more information will be supplied on everyone’s favourite subject – director pay.

Indeed, future remuneration policies, projected maximum payments and even bonus comparisons with ordinary staff will soon be included in annual reports.

Now, these new disclosure rules came into effect only very recently, so few companies have actually published the extra details as yet.

But during the next few months, you’ll discover the additional information within the reports of many FTSE 100 companies. There could be juicy revelations within the banking sector…

Evaluating director pay and avoiding troublesome fat cats

I’ll now show you how you can evaluate director pay and avoid troublesome fat cats, and I’ll use Victrex (LSE: VCT) as an example.

This FTSE 250 mid-cap manufactures a heavy-duty thermoplastic and has just issued its annual report with the extra pay disclosure. Here are a few points I’ve noted from that report:

  • Chief executive David Hummel has led the business since 1993.
  • During the last five years, his base salary has risen about 10% to around £463,000…
  • …and he has collected total pay, shares and bonuses of £6.6m.
  • Meanwhile, the ordinary dividend has been lifted 124% during the last five years…
  • …and the share price has returned more than 250%.
  • Mr Hummel owns 3 million shares, which gives him an annual dividend income of more than £1m.
  • Mr Hummel collected no bonus during 2009 and 2013.
  • Mr Hummel’s basic pay advanced 4% last year and will be unchanged in 2014…
  • …while his staff saw their pay rise 5% last year and are in line for a c3% rise this year.
  • The average UK Victrex employee earns less than 10% of Mr Hummel’s basic pay and collects a £2,000 bonus.
  • Victrex’s total staff costs gained 7% last year but the cash dividend paid climbed 16%.
  • This year Mr Hummel could earn up to £1.6m from pay, bonuses and other benefits.

So quite a few stats there, and I didn’t even delve into Mr Hummel’s share awards or pension scheme.

But from those points, we can get a good idea of whether this chief executive is taking the mick out of shareholders.

His pay has risen by 10% when the dividend has jumped 124%

For me at least, the litmus test is always what happens with basic pay – as that is always paid to the executive and is the base on which bonuses and other hand-outs are set.

So for Mr Hummel, I am impressed his basic pay has risen by 10% in the last five years when shareholders’ income (i.e. the dividend) has jumped 124%.

Another positive for me is last year’s dividend rising faster than total staff pay, which in turn outpaced Mr Hummel’s own pay.

And I like the fact Mr Hummel collects more through dividends than he does in basic pay.

All told, I’d actually deem Mr Hummel a textbook ‘thin cat’ in light of the shareholder rewards he’s produced at Victrex over the years.

True, he gets paid very well in comparison to his average employee – but I think he’s worth it. And the annual report says 99.8% of shareholders voted through his pay last year.

During the next few months, hundreds of quoted companies will publish annual reports containing the extra information on executive pay.

The reports could make for uncomfortable reading for many shareholders and directors, and perhaps unmask exactly which bosses are trousering far too much cash at YOUR expense.

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>Maynard does not own any share mentioned in this article. The Motley Fool has recommended shares in Victrex.