Bear's Conclusion on SBC and GAAP

…until I’m convinced otherwise, anyway.

This board and many other entities in the investing world have long debated GAAP vs non-GAAP. Saul has declared non-GAAP his method of choice because it gives a better understanding of how the company is growing. It’s a little silly to say some company grew EPS 2,000%, when really they make 2 cents every quarter like clockwork, but because of a one time event suddenly had a 42 cent quarter GAAP-wise. This, as Saul rightly points out, is the entire point of non-GAAP. Adjusted (non-GAAP) earnings back out the 40 cent even and show that the company’s earnings didn’t really grow at all.


The weakness of non-GAAP is when you’re not trying to look at growth, but profitability. In other words, you’re not comparing this quarter to the YoY quarter (or this year to the YoY year) – you’re simply looking at margins. The problem with non-GAAP margins is that SBC is backed out. Think about it: companies can show more non-GAAP net income by increasing their SBC. Your Income Statement could actually look like this:

Rev      100
Exp      150
SBC       75
Net Inc   25

That isn’t right! The company spent 50% more than they made, and non-GAAP earnings show they made a 25% profit! HA! Just because my hypothetical company covered half their expenses with shareholder dilution doesn’t make it a profitable company.

Real world example: Splunk lost 82M on 280M revenue (-29%) last quarter and showed +0.08 EPS. Talend lost 8M on 36M of revenue (-22%) and showed -0.20 EPS. These non-GAAP EPS numbers are not at all useful in comparing these two companies. You have to look at the big picture.

Just a note: GAAP is not the answer. The one-time 40 cent quarter from the example above would still need to be backed out when looking at profitability. You just need to back out SBC too – not as much when you’re comparing what the company did this quarter to a prior quarter, but absolutely when you’re trying to find out what the big picture looks like.



SBC should be taken into consideration but SBC has to be interpreted carefully.

It should not be looked as percentage of revenue. For company like SHOP with high valuation, SBC is not going to be so dilutive as a company with a lower valuation.

Also not all SBC is similar. It is fairly routine for software programmers to be offered SBC wherein they can buy company stock at 15% discount. The money for buying this comes from employee paychecks which is already expensed. In fact company gets paid by the employees. For the company it is effectively a secondary at 15% discount. But the actual accounting of this in GAAP vs Non GAAP makes it look far worse than it actually is.

In the end what matters is percentage of increase in absolute share count. What I like to look at is growth rate adjusted for increase in share count. Keeping track of share growth count, cuts through all the accounting/valuation details which can paint an unrealistically optimistic or pessimistic. scenario.

For example CRTO (When I was following it), was having a share count increase of 5% annually. It’s non-gaap profit growth was around 35% (plucking from memory). Non-GAAP adjusted for increase in share count would be 30% - which is the net value addition for existing shareholders. Looking at GAAP would make it look far worse than it actually was.


“they can buy company stock at 15% discount”

That’s an ESOP, and is different from SBC. Many more employees are in ESOP’s than get SBC.

The problem with non-GAAP is that there are so many kinds. Management can use it to hide problems which we’re trying to uncover. Saul is using his versions to reveal a more accurate picture. If we could trust management to do the same (such as with a company like Berkshire Hathaway), there wouldn’t be a problem.

It also depends on the kind of one-time event, the amount of SBC, the kind of business the company is in, etc.

a share count increase of 5% annually. It’s non-gaap profit growth was around 35% (plucking from memory). Non-GAAP adjusted for increase in share count would be 30%

Not to be picky (honest!) but .35/1.05=33.33%


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companies can show more non-GAAP net income by increasing their SBC.


I don’t think you have that correct at all.

Think of it like this. A company makes $20 million GAAP net income and puts it in the bank.

Then they give employees $1 million in stock options. They still have the $20 million in the bank. Adjusted would say they still have the $20 million net income, they just diluted the stock. GAAP would say they now have only $19 million net income.

Now lets say they do what you say, and increase their SBC to $5 million. Does this let them show more non-GAAP net as you say?

I don’t know what you are talking about! …Increasing SBC doesn’t give them more net income! Non-Gaap net income would still be $20 million, and that’s still what they actually made, and it’s still what they have in the bank to show for it. They just diluted more. GAAP would make believe they don’t have $20 million in net income, but just $15 million.

I don’t like the stock dilution either, but I object to GAAP making believe that they don’t have the earnings.




Except that increasing SBC does allow them to increase or maintain net income, if they’re doing it in lieu of a cash bonus for the employees. Revenue and operating expenses aren’t common statistics to be reported per share. Main statistics you get per share are FCF and earnings. It makes it difficult to compare businesses when SBC is all over the place.

Ultimately, that SBC is a cost of doing business, it’s just coming out of shareholder pockets due to dilution. When comparing two companies in the same field, the one with significant SBC looks way more profitable when using non-GAAP, even if both companies had the same revenue.

I’m all for some SBC to align executives with shareholder interests. What I do object to is massive amounts of it, where more money than their entire net income goes to executive pockets. At that point the entire idea of rewarding shareholders that invested and helped grow the business, just goes right out the window.


I’ve seen the discussion of SBC and GAAP come up several times here, and I think the divergence of opinion relates to people expecting GAAP rules to be all things to all people in all industries. The GAAP rules can’t do that, as business practices in different industries at different stages of their life cycles have different needs.

To start, I think it helps to think of the financial statements as a chapter of the book, and GAAP is the language that its written in. Like any story, its open to interpretation (what’s important to the user of the financial statements) and sometimes the language gets lost in translation (GAAP rules not always being the best set of measurement rules for that company).

So for SBC, its important to understand it within the context of the story. I won’t try to provide examples as I think everyone understands what SBC is and how it affects things, but I want to caution people about either blindly following the GAAP rules on this, or blindly dismissing them. As always, the “truth” is somewhere in the middle.

The way that I like to look at SBC is the trend. Is it increasing? Is it decreasing? Is it decreasing as a percentage of revenue, etc etc? But ultimately it comes down to what is important to you as an investor. Only you can make that decision for you.