It never ceases to amaze me how often I come across small companies with executives who are paid excessive amounts for mediocre results. Almost invariably, these executives own a large (often majority) portion of the company, and so a potential investor must recognize that these levels of compensation will almost certainly persist. Potential catalysts for unlocking value are consequently minimized, so it is important for value investors to consider whether these company are value traps.
Consider Tofutti Brands Inc. (AMEX:TOF), a producer of nondairy food products for health conscious individuals and those who are lactose intolerant. The company earned $506,000 on sales of $18.6m in its most recent fiscal year, a ROE of 12%. The company paid its CEO and CFO a combined $1,086,000, more than twice the company’s earnings and nearly 6% of revenues. Even worse is the fact that the CEO’s salary and bonus are clearly not linked to the company’s performance, as his total compensation package was steady for 2007 and 2008, despite earnings declining by 50%. It is easy to see where a potential acquiror could recognize cost synergies, as the elimination of these two compensation packages could immediately triple the company’s earnings, making the current market cap seem like a bargain. Obviously, on a stand-alone basis the elimination of these two roles could not occur, however more reasonable compensation packages could easily double the company’s earnings, leading to a P/E of less than 10.
Unfortunately, it is unlikely that value will be unlocked anytime soon, as the CEO and CFO together personally own 55% of the company. I consider this to be tantamount to half the shareholders receiving a dividend at the expense of the other half, and I am staying away.
Author Disclosure: No Position.