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Hi everyone - my first post on this esteemed board.

Costco looks very interesting - even with the recent price run-up of the last month or so. COST is selling at prices that are close to five-year lows.

While doing my fundamental research - I was dismayed about the amount of options issuance.

Using Costco's 10-K's and the company's own Black-Scholes estimates of the options' value, I get the following annual issuance stats:

1) Year
2) BS-Value of options granted
3) Pre-tax income
4) options as % of pre-tax income

1998
$ 83.1 MM
$ 766.4 MM
10.8%

1999
$ 141.1 MM
$ 858.9 MM
16.4%

2000
$ 152.6 MM
$1,052.4 MM
14.5%

2001
$ 136.5 MM
$1,003.5 MM
13.6%

2002
$ 136.2 MM
$1,138.1 MM
12.0%

I can make adjustments to my IV calculations for the implied expense of these options as well as the forward-looking dilution factors. However, at what point do you say to yourself that this is just too much of an edge that insiders are taking at shareholders' expense.

My dilemna is that like DELL, I'm extremely impressed with the business model and the management team's execution against that model. By all respects, I'm sure the management team is ethical and very focused on their business.

But my question is at what level of options issuance percentage is it too much? At what level does it (the excessive options issuance) override the go/no-go investment decision?

I'd appreciate people's opinions. I know greenmartian2 and others have a great deal of experience in this area.

Thanks in advance
bvalue
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No. of Recommendations: 7

By all respects, I'm sure the management team is ethical and very focused on their business.

But my question is at what level of options issuance percentage is it too much? At what level does it (the excessive options issuance) override the go/no-go investment decision?


For me, if I'm sweating the option issue with a company then it's a no-go. I don't have a defined limit or anything. It's just weighed versus all the other factors of a company.

I like Gentex a lot, and while they're not an options abuser by any stretch, they do like them as compensation tools. But there are so many things, currently, that make Gentex compelling that I'm not sweating the options issue.

Think back to the mid 1950's. A young kid wants to manage your money, but wants an option in return. Well, it's Warren Buffett, who only kicks in $100 for the first partnership. His pay is to take 20% of any gains over 6%.

Buffett made a ton of money off this deal. But the partners were rewarded as well. And most important, his pay (or option) was deducted from the partnership's returns (i.e. his option was expensed).

A long-winded way of saying: if the benefit outweighs the cost it's a good deal.

For this, I like the method often seen in Proxy Statements. Here the company will often show what a CEO's current-year grant will be worth if the stock appreciates 5% a year over 10 years (brought back to present value).

Since 5% is nothing to write home about, you can gauge how egregious the pay is based on sub-par performance.

-Ryan

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I know greenmartian2 and others have a great deal of experience in this area.

Fwiw, before roark came along, I didn't fully appreciate the significance of this issue either. But my results were fine despite my ignorance, though I was aware what company really stunk and which ones didn't.

Fwiw, two of my best performing stocks were option abusers - Hot Topic
(HOTT) and Christopher and Banks (CBK). You could easily find fault with 99c Store's (NDN) plan too. I do not have any hard and fast rules on this issues. My current approach is to calculate my normal array and then use roark's approach to value them for second set of valuation numbers, while at the same time realizing that business performance can completely overwhelm this entire issue (at least in the short-term, and that could involve a period of many years.).

As Ryan said, I think you judge this issue in conjunction with many other things you learn about the company (and Buffett's retained earnings commentary has particular relevance when you look at Ryan's 5% proxy reference), but options abuse does seem to be a telling sign that management is out to line their own pockets first.
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Costco's option grants as a percentage of outstanding shares were 1.95% in 2001 and 1.67% in 2002 by my calculations; that's before cancellations that have run at about 8-10% of annual grants. Those aren't unusually high percentages, but they're at the upper end of the range I consider tolerable for most companies. However, when I look at the entire compensation picture at Costco I don't have an issue with their option grants; nor does Charlie Munger, who is on Costco's board and not generally a fan of options.

The top 6 officers of Costco got a combined 8% of the total stock options. They use most of the options for people like purchasing managers and store managers. Also, their executive compensation is paltry by today's standards for companies of their size. For the 2002 fiscal year, Costco's CEO (James Sinegal) got a salary of $350,000, no bonus (none of their executives did because the company didn't hit its performance objectives), $23,756 in other compensation and stock options on 150,000 shares. If you use Buffett's rule of thumb that a 10 year option is worth 1/3 of the strike price and assume a $30 strike price, that means Sinegal's total compensation for fiscal 2002 was less than $2 million. In today's world, I view that as a bargain.

I've seen Sinegal on more than one list of executives that deliver the most value for shareholders relative to their pay.
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I like Gentex a lot

What do you think about Gentex right now? Isn't the price a bit rich given the soft auto market?

PP
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What do you think about Gentex right now? Isn't the price a bit rich given the soft auto market?


I wouldn't be a buyer above $25/share (GM would be up ~16% from the last heads up I gave him ;)). However, the future's quite bright and I wouldn't want to be completely out of the company either (barring some real irrational pricing).

-Ryan
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GM would be up ~16% from the last heads up I gave him

should have taken that tip. Unfortunately, I STILL haven't added GNTX to my 'select list'. And it makes sense to add one in this general industry, since I follow SUP already.

Don't know about you folks, but I've been having trouble getting through my usual number of companies. Part of it was the incredible amount of transactions in Q1 (slowed WAY down lately), part of it is due to all the conference calls (thanks Fool!), and part is the time of year (annual report, annual report, annual report). Of course, my very brilliant looking DLTR, BJ, JILL, and ANN sells suggest that sloth wouldn't be a bad thing, though I'm at an all-time AUM high despite the apparent goober moves...
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I regret not pulling the trigger under $20 some time ago.
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Hey PhoolishPhil,


What about SGP? You still looking at that one?
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I'm in ankle deep and thinking about getting in a little deeper.
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I'm about ankle deep as well. Just warning you .... :)
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