Should You Bet the Farm on Family Firms?

AnnaLisa is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

After the firing of George Zimmer, Men's Wearhouse's founder and face of the company,  hit the wires Panera Bread co-Founder and co-CEO Ron Shaich posted his opinion on LinkedIn that a founder has much more invested in a company and will try his/her best to do right by their creation.

More interesting is what happens after a founder passes the baton to his family, who may not be as emotionally invested and if publicly traded, have to answer to shareholders.

A  Boston Consulting Group study as reported in the Harvard Business Review found,"...during good economic times, family-run companies don’t earn as much money as companies with a more dispersed ownership structure. But when the economy slumps, family firms far outshine their peers. And when we looked across business cycles from 1997 to 2009, we found that the average long-term financial performance was higher for family businesses than for nonfamily businesses in every country we examined."

The family firm model

 J.M. Smucker (NYSE: SJM), the food manufacturer, is an example of a family-run company that doesn't get a perfect corporate governance risk rating because of shareholder rights (the worst score of 10) and Board (again 10)  due to the generally more chummy nature of family run firms. In their case it certainly hasn't hurt the stock's performance despite the fact there is a Smucker as CEO and several more as executive officers.

Dr. Chris MacDonald of Ryerson University explains the concern of shareholders, "there’s a worry that the family’s influence might not always work in the interests of other shareholders. And this worry is exacerbated by the fact that family-controlled companies often don’t stick to widely-acknowledged best practices in terms of corporate governance."

In the case of J.M. Smucker it is not family controlled as family members don't own 30% plus of the stock, it's less than 5% but four Smuckers together own over 1.3 million shares.

The company was founded by a Smucker forbear who sold apple butter off a donkey cart. Still nestled at One Strawberry Lane in Ohio the company has grown to a $10.93 billion market cap.

The company offers a 2.00% yield with a forward P/E of 16.13. J.M. Smucker trades at 2.13 times book and has a 2.29 PEG.

The main advantage of family run companies according to the Boston Consulting Group  is a frugal approach to their businesses, " We believe it’s possible to identify one ( a family company) just by walking into the lobby of its headquarters. Unlike many multinationals, most of these firms don’t have luxurious offices." Investing guru Peter Lynch also found fancy trappings suspect.

Contrast this to family controlled company, confectioner Tootsie Roll (NYSE: TR). Chairman and CEO Melvin Gordon, age 93, and his President and COO wife Ellen, age 81, receive over $7 million in pay between them, have almost unlimited access to the company jet, and a subsidized apartment to the tune of $10K per month. Tootsie Roll has been under control of members of the Rubin-Gordon family since the Great Depression.

Corporate governance risk score is also high due to Compensation risk with other officers' pay in the million dollar plus range.Tootsie Roll is a $1.90 billion market cap but Q1 net earnings came in at $9,069,000. 2012 net earnings came in at $52 million.

Excepting these concerns the company has a debt ratio of only 1.15 and repurchased $9 million worth of stock in 2012 as well as paying out its 48th consecutive dividend.

The Board has been characterized as secretive and a crony culture by The Wall Street Journal with average tenure of three decades. Both Gordons are on the Board. Despite these risks it must be noted the stock has gained 34.26% this last year. The company offers a small yield of 1.00% and has a trailing P/E of 36.61. Analysts expect 9.00% five year EPS growth.

Another worry of potential investors in family firms is innovation. Not to worry with Smucker; the company has made many acquisitions in the last decade with the most valuable being Folger's coffee which they bought from Procter & Gamble. This one buy dramatically changed their fortunes as a jam and jelly company to a food power equal to competitors Mondelez International (NASDAQ: MDLZ), also a competitor to Tootsie Roll, and ConAgra Foods.

Meanwhile, Tootsie Roll, has plodded along with mostly old-fashioned brands:Tootsie Roll, Sugar Babies, Junior Mints, Nik-L-Nip, Dubble Bubble, Andes Mints, and Charleston Chew. Granted they are well-known brands but the company has changed them very little.

The short interest in the name is increasing and in mid-June stood at 16.50%.

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SJM Return on Equity data by YCharts

The corporation model

Since Mondelez competes with both a comparison is advisable. Mondelez spun off Kraft Foods Group last fall keeping CEO Irene Rosenfeld and most of the snack, candy, powdered beverages, and coffee.  It is five times the size of J.M. Smucker at a market cap of $50.91 billion and has a trailing P/E of 18.38 with a PEG of 1.63 and a 1.80% yield. It trades at 1.63 times book.

Not family run anymore, the company did start as a family business (no relation to me) in 1903 when J.L. Kraft started a wholesale cheese business.

Mondelez is the example of a company with innovation and the more generally accepted business model of the modern corporation with a corporate governance risk score of 5, better than these family run companies. However, Mondelez runs with a much higher debt ratio than Tootsie Roll or Smucker as most major food giants do.

The Foolish takeaway

While J.M. Smucker is an example of a family company that is facing the future with innovation and growth, Tootsie Roll should concern investors with the worst of family firm disadvantages, doing things the old way and keeping a crony Board without the benefit of frugality.

As J.M. Smucker has run big over the last few years, seemingly at new all time highs every day it would be wise to wait for a pullback. But its strength in incorporating the best practices of a Mondelez like international expansion and accretive acquisitions should keep it on your shopping list.

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AnnaLisa Kraft has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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