Is stock-based compensation (SBC) a real cost for a company? Many investors don’t think so because they believe as long as the company doesn’t pay any cash, there’s no cost.
That’s not true. The cost is the dilution of current shareholders’ interests.
As Warren Buffett wrote in Berkshire Hathaway’s letter to its shareholders, SBC is an example of a hidden cost which the management would always expect investors to ignore.
But, if that doesn’t count as a cost, what is cost?
Companies listed in the United States need to report their financial results with generally accepted accounting principles (GAAP). But many also offer non-GAAP results as a reference to investors.
A big difference between the methods is whether SBC will be counted as cost.
A 3 to 5 percent SBC may not matter much. But according to analysts at Sanford C. Bernstein, the SBC at social networking service Twitter accounted for 247 percent of its profit last year under the non-GAAP reporting standard.
More importantly, excessive SBC would create a vicious cycle if the stock price falls. Too many newly issued shares would suppress the stock price, and the company would need to give more shares to the talents they want to keep amid the lower share price.
S&P 500 rose 1 percent last year, but Twitter’s share price dropped over 60 percent.
The good quality of a service or a product is not enough to make a company worth investing in.
With such SBC, are you still willing to be a Twitter shareholder?
Before picking a stock, have you spent time to figure out the difference between GAAP and Non-GAAP reporting standards, their difference from International Financial Reporting Standards?
Fundamental analysis is necessary.
This article appeared in the Hong Kong Economic Journal on March 16.
Translation by Myssie You
[Chinese version 中文版]
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