Lousy Offices, Great Investments

Lousy Offices, Great Investments
By Bill Barker (TMF Lazarus)

Maybe it was the lobby of the office building, which is a cross between 1960s public elementary school color schemes and Soviet warmth. Maybe it was the office space itself, in which, if memory serves, the receptionist's desk was within about six feet of threadbare carpet from the doors to both the CEO's office and the main (only?) conference room. Maybe it was having to ask for a key to get to the restroom, which was outside the company's actual office space and in a hall shared with other companies.

Actually, it was just the whole thing. There were alarm bells going off -- figurative ones, fortunately -- and they were screaming, "This is the kind of company you really want to think about investing in."

In this particular case, Motley Fool Hidden Gems advisors Tom Gardner, Bill Mann, and I were at the office of Drew Industries (NYSE: DW), meeting with its CEO and CFO back in August. The whole experience was a rather flagrant reminder of words that come out of Peter Lynch's No. 1 bestseller (or so the cover tells me), Beating the Street. Lynch remembers why he was so interested in Taco Bell, now a part of Yum! Brands (NYSE: YUM):

Taco Bell I liked because of its tasty tacos, because 90% of the country had not yet been exposed to the tasty tacos, and because the company had a good record, a strong balance sheet, and a home office that resembled a neighborhood garage. This leads me to Peter's Principle No. 7:

The extravagance of any corporate office is directly proportional to management's reluctance to reward shareholders.

By numbering this and setting it off with bold typeface and special indented margins (which I've replicated here), Lynch must think pretty highly of this principle. It's held true for Drew shareholders. Drew has not wasted any shareholder money on extravagant office space, and its shareholders have enjoyed 59% compounded annual returns over the past five years. Drew is hardly the only example of a miserly approach to office space expenditures leading to superb long-term returns for shareholders. Berkshire Hathaway is legendary for its Spartan offices and has been anything but reluctant to reward shareholders. Not too surprisingly, Costco (Nasdaq: COST), a Charlie Munger favorite, is almost as legendary for its economical use of investor funds on office space. It acquired its office furniture -- used -- from Boeing (NYSE: BA).

Consider this example from The Power of Fastenal People, written by Fastenal (Nasdaq: FAST) CEO Robert Kierlin: "When we only had about 30 employees in our Winona office and warehouse, all of the men signed up for their week to clean the men's restroom, and all the women signed up for their week to clean the women's restroom. We saved by not hiring out janitorial services and kept egos in check (we also were more careful about keeping the place clean)." And then consider Fastenal's investment returns.

Back to Peter Lynch and tacos
Taco Bell, of course, rewarded shareholders for years after Lynch wrote about it, all the way up until it was acquired by PepsiCo (NYSE: PEP), which later spun it off into what is now Yum! Brands. I can't comment on whether the home office for Yum! Brands resembles a neighborhood garage. (I somehow doubt it.) By contrast, consider the Roman orgy that was Tyco in the days of Dennis Kozlowski. With its many stories of bacchanalia, Tyco stands as the late 1990s poster child of management extravagance -- which translated into its reluctance to reward shareholders.

Our Hidden Gems team has access to management and its offices that the average Joe may not have. The management teams at companies we follow (and recommend to subscribers) are generally willing to take our calls. They even return them and allow us into their offices for a chat when we ask, and that experience can produce some valuable insights. (Most recently, FARO Technologies' (Nasdaq: FARO) CEO gave us a very enlightening interview, which is available in audio form on our site for interested shareholders.) We're interested in the level to which management is rewarding itself, though that's far from our only concern.

The Foolish bottom line
Office lavishness is only one element of a company's willingness -- and ability -- to reward shareholders. But it can be a more important one than you might initially think. So check up to see how grandiose your company's home office is.

If it's a company in your area, drive by the facilities and make a reasonable guess as to how lavish management is treating itself. Call the investor relations department and ask probing questions about the state of corporate offices. ("So, how new is the carpet at HQ?" "Is there such a thing as the executive washroom?" "What's the most impressive feature of your office?") Even the company's annual report can give a sense of how the company thinks of its office living space.