By Anthony Ogorek
Williamsville, NY – The phrase, “nothing succeeds like excess,” would seem to be a fitting motto for the Nasdaq or New York Stock Exchange. Investors are led to believe that in a perfect world, the market would continuously climb, we would all be rich and no one would get hurt. Unfortunately, even if this scenario played out, it would still wreak havoc.
The whole Enron mess is but the latest reminder of the corrosive effects of a run away bull market. Powerful bull market moves create a kind of distortion field that is difficult for the general public to appreciate. Only with the passing of time do fissures in the great bullish fa?ade begin to appear.
During the late great 1990’s a culture developed that in essence said, “Money is money even if it’s funny;” and the funny money was stocks. During the Great Bubble, stocks were viewed increasingly as currency or money substitutes. Except that in certain circumstances, they were better than money. Astute corporations used their stock as a means of acquiring other corporations on the cheap. Rather than paying cash, they used their bloated stock shares as currency in acquiring other corporations for outrageous prices. When you’ve got all the money in the world, you may not be very sensitive to what you are paying for things, and this was certainly the case during the roaring ‘90’s.
But it did not stop there. Corporations and their accounting firms vigorously lobbied Congress to permit the impact of stock options to be treated more favorably than cash when computing corporate earnings. When a corporation pays an employee, the salary is counted as an expense of the corporation and will naturally reduce the corporation’s earnings. Stock options are of course compensation, but they do not count against a corporation’s earnings until the employee exercises them, usually 10 years after the options are granted. Therefore, industries that utilized stock options as an integral part of their compensation packages were reporting much higher earnings rates than corporations that paid their employees with cash.
When corporations issue stock options, they are in effect minting money. Where do they get the money from? Try existing shareholders. When a company issues new shares or options, it is diluting the ownership stake that each shareholder owns. Therefore, in order to reduce the dilution of shares caused by option issuance, the corporation must go into the open market and buy their shares back, even though the prices may be unrealistic.
This merry go round can only go on for so long- corporations using their inflated stock price as an excuse for overpaying for the shares of other corporations. The use of stock options not so much to motivate employees as to goose corporate earnings at the expense of “less fortunate” corporations. A substantial portion of corporate earnings during the late 90’s came not from core operations, but from corporate stock portfolios.
Is it any wonder that we are still in a bear market after nearly two years? Is it any wonder that corporate balance sheets are being scrutinized as never before? Is it any wonder that we will blame anyone but ourselves for the current state of affairs? Is it any wonder?
Commentator Anthony Ogorek is principal of Ogorek Capital Management in Williamsville.