# How to adjust GAAP EPS for share based comp

Here’s an example using the most recent BWLD earnings results:

BWLD doesn’t report adjusted EPS (only GAAP). This means that stock based compensation expense is double counted in their reported EPS. That is once for the expense and again because the earnings number is divided by the diluted shares including the new shares that were granted. Adding back the expense gives us a more accurate EPS number and it also allows for better comparison of P/E against alternative investments.

For those of you who are interested in learning how make the adjustment:

Step 1: Enter GAAP EPS number for the quarter. This quarter it was \$1.52.

Step 2: Find the share based compensation. This is a line item on the Statement of Cash Flows. The figure for this quarter is \$2.745M.

Step 3: Find the diluted number of shares for the quarter. This figure can be found on the Income Statement (BWLD calls it Statement of Earnings in their press release). This figure is 19.074 million shares.

Step 4: You can’t simply add back the share based comp per share because the company received a tax benefit so their earnings were higher for this tax benefit. You need to estimate their tax rate. To make it easy I have been using 30% for their tax rate. I haven’t checked it recently. If you can find a more accurate measure of their tax rate, use that number.

Step 5: Calculate adjusted EPS using the following formula:

Adj EPS = GAAP EPS + ((Share based comp * (1-tax rate)) / share count)

\$1.52 + (2.745 * 0.7) / 19.074 = \$1.62

When I did this for the past 4 quarters, I got adjusted EPS of \$5.47 for the TTM. The TTM GAAP EPS number is \$4.98.

Based on the current price of \$160.25, the TTM P/Es are as follows:

GAAP TTM P/E: 32.18
Adj TTM P/E: 29.30

Chris

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Chris, that’s terrifically helpful! thanks

Saul

Adding back the expense gives us a more accurate EPS number and it also allows for better comparison of P/E against alternative investments.

Chris,

Just .02, but your valuations using multiples will suffer using this approach. For a good discussion of the reasons why, please see:

http://aswathdamodaran.blogspot.com/2014/02/stock-based-empl…

So, what should you do, if you have to use multiples? First, stop adding back stock-based compensation to net income. There is no logical or financial rationale for doing so. Second, stop playing around with the denominator. If there are shares outstanding, restricted or not, count them. If there are options outstanding, value them and add them to the numerator (the market capitalization) and don’t adjust the shares outstanding for in-the-money, at-the-money or out-of-the-money options.

Thanks,
Ears

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First, stop adding back stock-based compensation to net income. There is no logical or financial rationale for doing so.

Expensing stock options is bad accounting which is the reason for adding back stock-based compensation to net income.

Denny Schlesinger

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Between Denny and Ears i have all the reasons I need to run screaming from the room when it come to financial analysis.

Try to get this - I don’t give a sh*t which one of you is correct. What’s important to me is will it make any difference in the investment decision process?

Mostly, from Ears posts I have learned a lot about why I should not invest in anything ever - maybe that’s an exaggeration or generalization or whatever, but it’s hard to glean any positive decision criteria from his posts. He’s obviously learned and well versed in financial analysis, but I just have trouble finding anything in his posts that sheds light on why one should invest.

Ears, if you’re reading this, don’t take it too personally, I well understand we each have our own investment style, risk tolerance, etc. etc. etc. I don’t know how old you are, maybe it doesn’t make any difference, but I’m of an age when most “investment councilors” advise 50% or more in bonds. I’m 100% in stock - not mutual funds, not ETFs, individual, hand-picked stocks. I have no idea what your investment profile looks like, but from your posts, I’d venture you’re 100% in a savings account - and worried.

I sometimes have trouble following Denny’s investment logic, but it’s not for want of logic. It’s my inability to grasp his analysis. I know he does not shy away from investments, but I sometimes just don’t grasp his strategy. Having said that, I’m also pretty sure Denny is well ahead of me in this game (and it is a game). So, he must be doing a bunch of stuff right, even if I can’t always follow it.

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Mostly, from Ears posts I have learned a lot about why I should not invest in anything ever - maybe that’s an exaggeration or generalization or whatever, but it’s hard to glean any positive decision criteria from his posts. He’s obviously learned and well versed in financial analysis, but I just have trouble finding anything in his posts that sheds light on why one should invest. Ears, if you’re reading this, don’t take it too personally, I well understand we each have our own investment style, risk tolerance, etc. etc. etc. I don’t know how old you are, maybe it doesn’t make any difference, but I’m of an age when most “investment councilors” advise 50% or more in bonds. I’m 100% in stock - not mutual funds, not ETFs, individual, hand-picked stocks. I have no idea what your investment profile looks like, but from your posts, I’d venture you’re 100% in a savings account - and worried.

Hi Brittlerock,
I find it a pleasure to have contrasting views on the board, and some negative views keep us honest, but I also have wondered why someone would post on a stock analysis board when he almost never has anything positive to say about ANY stock, and it sounds as if he is not invested in any individual stocks at all. But as I said, it’s healthy to have some negative voices around.

As for age, you are an old man after my own heart. I too am an old guy, older than you I’m sure, but also 100% in stocks at an age when they say you should be in bonds and cash, and just conserving capital (what nonsense).

Saul

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but also 100% in stocks at an age when they say you should be in bonds and cash, and just conserving capital (what nonsense).

Saul

There is a very good reason to hold bonds and cash. Diversification. Insurance.

Back during the high tech bubble I was making money hand over fist. In my earlier days in the market I used to have up to 30% in bonds and lots of cash. My stocks made up anywhere from 50% to 75% of the portfolio. Then came the heady days of the dot com boom and I figured it was nonsense to waste so much opportunity on cash and bonds. I sold the bonds and went on margin. I still remember fondly the day I made over \$80,000 dollars, that’s \$80,000 in ONE day, more than I had ever made in a full year working! Then the bubble burst. At midnight the coach turned back into a pumpkin.

If the portfolio had held about 30% in cash and bonds my loss would have been capped at maybe 50%, probably less. Without the protection of cash and bonds the loss was catastrophic. Not as bad as the idiot who mortgaged his home, put the money in the market, and piled margin on top. He went bankrupt.

The best description of the difference in strategy (bonds/no-bonds) are the words “robust” and “fragile.” It’s the exact same reason you buy insurance for your home even if the probability of it burning down is low. A once in a lifetime occurrence is too painful. If you don’t buy insurance you are, in effect, SELF insured. You take the loss like I did when the tech bubble burst.

I’m not saying you must have cash and bonds, there are other ways to hedge, only don’t say “what nonsense.” Be prepared for the consequences.

Denny Schlesinger

3 Likes

I sometimes have trouble following Denny’s investment logic, but it’s not for want of logic. It’s my inability to grasp his analysis. I know he does not shy away from investments, but I sometimes just don’t grasp his strategy.

One of the best lessons I got from my dad was to ask questions. He said: “Its better to seem dumb by asking a question than to stay dumb by not asking.” I had a lot of great teachers, people willing to answer all my questions. Besides, by asking me to explain my strategy you are doing me a great favor. Explaining it is a great way to find flaws in it.

Having said that, I’m also pretty sure Denny is well ahead of me in this game (and it is a game). So, he must be doing a bunch of stuff right, even if I can’t always follow it.

Don’t bet your bottom dollar on that! ;(

Robert J. Ringer (Winning Through Intimidation and Looking Out For #1) says that life is a game where we keep score with dollars. Since it’s only a game, we might as well play hard. Since no one ever got out of the game alive, don’t take it too seriously.

Denny Schlesinger

Winning Through Intimidation
http://www.amazon.com/Winning-Through-Intimidation-Robert-Ri…

Looking Out For #1
http://www.amazon.com/Looking-Out-Where-Want-Life/dp/1491582…

When I first read these books I didn’t think that Robert J. Ringer was a real person but more likely a pseudonym.

Robert J. Ringer
http://en.wikipedia.org/wiki/Robert_Ringer

1 Like

Robert J. Ringer (Winning Through Intimidation and Looking Out For #1) says that life is a game where we keep score with dollars.

Wow–I’ll agree that life can be viewed as game, especially by those of us lucky enough to be affluent enough to have our basic needs met. But there are many more important things to keep score on than dollars.

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I’m not saying you must have cash and bonds, there are other ways to hedge, only don’t say “what nonsense.” Be prepared for the consequences.

I view it differently. I say it depends on your situation. IF you are young and in a position of years ahead of you then you should be more in stocks. Most people might agree with this. However, if you are old the same allocations may be prudent for a different reason, but it depends on your circumstances.

As an example let’s take the Saul of 2015. He started investing in 1989 about 5 years before retirement. So let’s say that as a psychiatrist at 49 years old he had accumulated \$200,000 (just a guess). By 2015 that amount has now growth to about \$59,200,000. Saul seems like a simple guy without an expensive lifestyle. If his wealth dropped by 95% then he would still have \$2,900,000. While this is an enormous difference, I would bet that his lifestyle would be unaltered. What are the odds that his stocks would drop in value by 95%? Probably the same as the odds for armageddon. My point is that if your wealth is several times your needs you can be in stocks 100% even if you’re old. In this case, volatility is not a problem and you should probably focus on a strategy that will maximize your average annual returns on the portfolio. On the other hand, if you are old and your wealth is not sufficient to sustain a big drop without affecting your lifestyle then you will need to be more conservative in your investing strategy. There will be a spectrum of ideal strategies depending on the individual circumstances.

Chris

6 Likes

By 2015 that amount has now growth to about…

Chris, you forget that my family and I have been living on that money for 19 years now, since 1996. That reduces your figures by an enormous amount.

Saul

There will be a spectrum of ideal strategies depending on the individual circumstances.

Chris

Absolutely correct!

Denny Schlesinger

Chris, you forget that my family and I have been living on that money for 19 years now, since 1996. That reduces your figures by an enormous amount.

Of course. However, even with an enormous reduction, I think it’s safe to assume that if your portfolio value dropped by 75% then your and your family’s lifestyle will be unaltered for the rest of your lives. An old person who can’t say that would be prudent to be more conservative.

However, you made an excellent point: cookie cutter rules for investing allocations can be silly.

Chris

But there are many more important things to keep score on than dollars.

One form of scorekeeping need not be not exclusive of the others. You don’t need to be poor to be honest, moral, loving or charitable.

Denny Schlesinger

4 Likes

Brittlerock and Saul,

I too am an old geezer that started investing when Peter Lynch and Louis Rukeyser were buds on the Friday PBS program. I’m a couple of years from retiring from an extremely enjoyable career in dentistry.

My investments have been 100% in stocks for 3 decades and I have reaped so many benefits both financially as well as the emotional satisfaction from simply learning how the world really works economically. New products and services are constantly available for those of us who become part owners of these companies.

A lifetime of investing is a life rich in constantly learning as well as making so many friends with common interests such as exist on this board.

As one ages there are few things in this life that give greater satisfaction than seeing your hard earned money grow over the decades. We can become financially free to be generous with helping others as well as leave a nice nest egg for our children.

I have learned that the two qualities that will serve the investor well long term are a calm heart in the midst of the inevitable financial storms as well as the fearless courage to invest in solid oversold companies when everyone else is running for the exits. This board will help keep you grounded and profitable.

And for that I am very grateful.

Jim

9 Likes

Ears, if you’re reading this, don’t take it too personally

No worries. Labeling someone as negative or speculating about what they have or don’t have in their portfolio have nothing to do with the substance of what Chris was saying in his original post. So I didn’t take what you said personally, I took it as irrelevant.

If we focus on substance, then what Aswath Damodaran was saying is that adding back stock based compensation forces you into a valuation trap when comparing companies in the same industry. This may not be of interest to you, but it might be to others.

Ears

6 Likes

Jim, I have never posted to this board but have been reading it for a while and it is a real treat, but I had to jump in when you mentioned Louis Rukeyser, and Peter Lynch. I was watching Wall Street Week with Louis back in the days when Jim Grant and Marty Zweig, Peter Lynch and Mario Gabelli and other were regulars and we none had grey hair. It was a great show and I miss Louis’ incredible wit and sarcastic approach to most investment gurus.
I learned one very valuable lesson from Lynch during one of Louis interviews, and that was to look around at what you know. When every body and everybody’s grandmother (and yes I mean grandmother) is riding a Harley, and paying out the wahzoo for leather and studded boots, don’t buy the leather or the bike, buy the stock. When the biggest buzz going around between my co-workers on the north side of Houston in the early 80’s was that Wal-Mart was going to open a store up in Porter Tx, the first in the area, don’t spend your money at Wal-Mart, buy the stock.
I think it has been the greatest lesson I have learned and I owe that to Louis and Lynch.

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I learned one very valuable lesson from Lynch during one of Louis interviews, and that was to look around at what you know. When every body and everybody’s grandmother (and yes I mean grandmother) is riding a Harley, and paying out the wahzoo for leather and studded boots, don’t buy the leather or the bike, buy the stock.

I got a promotional email from exFool Tom Jacobs lamenting that too many graduates are going to go into debt with credit cards:

Dear Denny,

If we could reach every 18-year-old person in the country with this message, it would probably do more good for their financial future than any investing education could. Please pass it on.

Don’t invite me to be your graduation speaker. Seriously. My address would be, “Credit Cards are the Devil’s Spawn!” Hear the yawns?

To which I replied:

Tom:

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.”
–Winston Churchill

Not only are credit cards great money management tools provided you pay your balance on time, VISA and MasterCard are two of the best investment vehicles of the financial industry.

The Best Advice for New Graduates? Buy V and MA!

Cheers!

and it was the reason I started the thread::

Saul: V & MA? Date: 4/30/2015 8:56 AM
http://discussion.fool.com/saul-v-ma-31734471.aspx?sort=whole

Denny Schlesinger

3 Likes

oologah,

Your post brought back many fond and nostalgic memories of watching Wall Street Week with family and friends and learning to “keep the faith” amongst all the doom and gloom of the ever pervasive bears.

“Looking around at what you know” is indeed a super investment tip. A lifetime of investing will help us keep our finger on the pulse of what consumers are excited about and oftentimes a profitable investment opportunity.

I remember watching Louis interviewing his wise father who was in his 90’s I believe. After a long market swoon Louis said: “Dad, you have been investing for over 50 years. Does this huge drop in the market worry you?” His father waved his hand dismissively and replied: “Louis, this is nothing. I’m buying more GM and GE and other stocks to take advantage of this wonderful pullback.” This from a man over 90 years old!!!

That wisdom has proven true over the past 30 years and will continue being so for the future.

Jim

1 Like

I’m buying more GM and GE and other stocks to take advantage of this wonderful pullback.

Times change. In 2008 GM went broke and GE was on the brink had Warren Buffett not helped out.

The most fun car I ever owned was a 1962 Corvette Stingray but when GM offered me a job I turned it down. I never liked the company.

Denny Schlesinger

Hardtop, black, white leather seats, fun…