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Friday, December 30, 2011


2011 Heads for History's Ashcan

With Sears / K - Mart announcing store closings following yet another moribund Christmas performance, it's time to repeat (in our typical "I told you so" fashion) our take on the company and its owner/hedge fund investor Eddie Lampert. He's a Cramer fave and bought control of Sears based on financials (it was allegedly undervalued). You have to be careful with this. Sometimes companies, especially retailers, are undervalued for good reason.

Now I have respect for Cramer and little doubt concerning Lampert's genius as an investor/financier. Unfortunately, those talents have little to do with operating a business. Sears problem was not so much overspending as it was under-marketing. It simply had an outdated business model that is only getting worse. Adding K-Mart compounded the felony, taking a discounter that was being run over by WalMart, and adding it to a failing business. So all the while Cramer was touting this stock based on his friend's capabilities, we were warning our readers to stay away. A more aggressive posture would have been to short the stock.

This just proves that even as smart an investment advisor as Cramer can have blind spots. He also would advise you to do your own research, and I warn you not to take any advice from this space for the same reason. I can't think of a better illustration for taking my, and everyone else's, disclaimer seriously. There are no guarantees. Period.
Speaking of CNBC's very smart commentator/analysts, there is none better, in my opinion than the Chicago based commodities/bond follower, Rick Santelli. He is extremely entertaining, like most of the station's analysts, which is why the station is so much more watchable than either Bloomberg or Fox Business. But like many folks who follow the bond markets, Rick is so clear-eyed and skeptical that he is a welcome counterweight to most of the stock analysts who are biased to the bull side. Rick's honesty and courage to say (or even shout) what he thinks got him in trouble with the Obama Administration in its early days, but he has been totally and consistently vindicated.

One of our most loyal readers sent me an article from the NY Times written by one David Kocieniewski pointing out an apparent loophole for corporations in the tax treatment of stock options allegedly costing the Treasury gobs of money, according to geniuses like Michigan's Senator Carl Levin (who never saw a dollar he wouldn't tax). This has come up because the options issued during the 2008-09 market collapse are starting to come up for exercise and executives are realizing windfalls while their employers are realizing outsized deductions. For example, the author points out that Sirius CEO Mel Karmazin's options exercisable at $0.43 now purchase stock trading at 1.80. Sirius allegedly gets a deduction at the higher price when he exercises.

So let's set the record straight, since the Times suffers from its chronic inaccuracy as well as its anti-business bias. First, there is no information regarding whether these, or any of the options discussed in the article are qualified or non-qualified, which makes a huge difference in the tax treatment. But let's put that deficiency aside and talk in general about non-qualified options, which most are. When the options are granted, it's a non-taxable event, though the company reports a non-taxable expense for the "value" of the options granted, which is the number of options times the market price of the shares. Never mind that this is not really an expense at all to the company, since no cash changes hands at that point. This accounting treatment is the result of a galactically stupid law passed some years ago to try to get companies to issue restricted stock instead of options (I'll give you two guesses which party wanted that law), never mind that any executive in his right mind would actually prefer to get restricted stock.

When the options become exercisable, the executive pays ORDINARY income tax on the increase in price above the strike price, even if he keeps the stock. So this is hardly a sweetheart tax arrangement for the executive. The corporation gets a deduction for the amount of income the executive takes (not for the price of the stock as Mr Kocieniewski misleads his readers). This makes sense since compensation is supposed to be a neutral taxable event. The corporate payor's deduction is supposed to be equal to the employee/executive's reportable income. There is nothing unfair about the tax treatment.

My gripe, which was printed in this blog back in 2008-09 (and someday I will print all these posts so I can direct you more specifically to our archives) was that the collapse in stock prices was setting up executives for these huge paydays at the expense of the public stockholders. Since companies determine the number of options to give out based on a percentage value of salaried compensation, and strike prices were depressed, there were outsized awards being made, which I pointed out would dilute the holdings of public shareholders and reduce earnings per share. And this is precisely the result that has the Times in a lather. But it has nothing to do with taxes.

In fact, to a great degree, this is the unintended consequence of liberals' ill-fated attempt to deal directly with outsized executive salaries. They decided to pass legislation denying ordinary corporate deductions for salaried incomes above $1 million, forcing companies to compete for executive talent by compensating them in other ways than through salary. The result is outsized stock awards, either through options or restricted stock, which from the point of view of the ordinary investor is worse than salary. Forget about aligning executive and shareholder interests, we don't need your help Mr. Levin. Can't you ever leave well enough alone?

Now Levin has the bright idea that he'll deny the deduction for compensation over $1 million however it's paid. This is typical Democratic class warfare, "fairness," jealousy, whatever you want to call it. It won't work.

Investors need to stand for their shareholder rights and not be victims, and not depend on Congress. In 2008-09, it was clear to many of us that we needed to vote against certain incentive compensation awards, and I did so. If you don't like what your company is doing, sell the stock. I will say, as a Sirius holder, Mel is worth every dollar he's been paid, and I felt that way then and I feel that way now. The company was all but dead when he came in.

Freddy Cole's show at Birdland was so memorable. If anything, he is better than ever, and I bought his CD's after the show, and he signed my box. His working band is wonderful. When he sang The Christmas Song, made famous by his older brother, I doubt there was a dry eye in the house. But all the songs were excellent, and I especially loved I Was Telling Her About You, written by Bill Charlap's father.

On Tuesday, after a hard (and reasonably successful) day at the bridge table, I went to hear the Birdland Big Band and stayed for both sets, each one well over an hour. So it was a late night but a very satisfying one. The Band was in top form, and I even got a ride home from NY trumpet legend Glen Drewes.

On 12/21, we bought 300 shares of IDT at 9.35, a zero buy. On 12/23, we sold 600 shares of FSI International (FSII) which has had a nice run. We got 3.63 this time for shares we bought on 9/8/09 for 1.01. On 12/27 we sold 100 shares of Pfizer (PFE), a nicely recovering stock, which is now an income stock rather than a growth stock. This was in the IRA so the loss won't help with this year's tax return. We got 21.77 for shares we bought for 41.20 on 12/11/01. Recent purchases have been at a much lower price. On 12/29, we bought 100 shares of Protective Life preferred (PLP) for 23.30 for the IRA. Today, we sold 100 shares of Lancaster Colony (LANC) out of the IRA for 70.48. We paid 35.85 on 3/12/03. That's almost a 9% compound return. They can't all be gems.

We'll summarize the year for the Redwave portfolios after we get the brokerage statements and crank in the December dividends.

Happy New Year to all our readers!

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