It still amazes me!

I studied and practiced accounting even if I’m not a certified pubic accountant. Expensing stock based compensation is a terrible piece of bad accounting. It’s a bit complicated but I’ll try to simplify it.

There is no question that stock based compensation is an expense that the stockholders have to pay. That’s not the issue. The issue is the proper way to account for it. The first concept that one has to have in mind is that the company is a separate entity from its stockholders.

Thanks Denny, I’ve tried to explain a dozen times that stock options and stock-based compensation dilute the stockholders, but they don’t affect the company, or its net income, at all. GAAP just forces companies to make believe it does. Nice to hear it from an accountant.

Saul

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I know you are angry at stock based compensation, but…

It’s silly to be against stock based compensation as an ideology. The position I take is “What’s in it for me?” If the stock is outperforming then I’m OK with what management is doing. If the stock is underperforming I vote with my wallet and sell the stock. I see no need to take an ideological stand.

Denny Schlesinger

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I know you are angry at stock based compensation… - Saul

Angry? Far from it. I try to invest as rationally and dispassionately as possible. And the moniker is putnid…not putrid.

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Denny,

I have about concluded that idealogy is for the weak minded.

Cheers
Qazulight

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And the moniker is putnid…not putrid.

Sorry, that’s my goddamn spell-checker feeling it has to stick its two cents in.
Saul

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No worries, Saul. I’m and easy-going guy.

Thanks Denny, I’ve tried to explain a dozen times that stock options and stock-based compensation dilute the stockholders, but they don’t affect the company, or its net income, at all.

have to say this - then what exactly are you - not a shareholder??? I don’t understand your point - if you own the stock, you ARE a shareholder, and you’ve got to be irritated by it. It is nonsensical to defend this as something not to be bothered with unless you are on the privileged few who get compensated this way.

Buying a share represents part-ownership in a business, and if you use cash flow to buy shares and the share count ends up stable then the money spent to buy shares is clearly money gone.

My problem with shareholder comp is that it is almost always abusive because it allows Mr. Market to establish a value for the compensation, it is almost never tied to a specific individual’s direct effort (you can be mediocre in your job and still get higher compensation cause the company does well), and often times companies issue options again and again and varying prices and finally there are absurdly long periods where the option/restricted stock can be exercised. Bottom line - the shares are positively rigged for insiders. These are in essence a privileged shareholder class where the instruments bear no resemblance to the cheap crud known as common shares that you and I buy on a stock exchange. It ought to be illegal.

Yeah, I hate the stupid things.
Anybody sane agrees with me.

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It is nonsensical to defend this as something not to be bothered with unless you are on the privileged few who get compensated this way.

Is it? Even if you own the stock as the share price triples in a year’s time?

I’m with Denny. Share based compensation isn’t “good” or “bad.” It is what it is. There are benefits to the company, as Saul has pointed out. There are drawbacks to shareholders (dilution), as many have pointed out. It can be reasonable or excessive. It can be used wisely or poorly. No need to take a moral position on it.

Can we please move on?

Bear

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Anybody sane agrees with me.

I wouldn’t go that far. It simply depends on your perspective. Take the company’s view. They may have the best idea in the world, but not enough money to fund it before “x” figures it out. They need to find talent to employ the best idea in the world so they give talent equity they couldn’t otherwise afford to pay. It’s pretty simple.

Without this, so many companies that exist today would have never had the chance to get going. Further, what does it matter? As an investor in a public company, you can look at the diluted share count year over year, figure out the dilution and compare it to the performance of the share price or your expectations. What is the big deal?

It is all a matter of growth versus dilution.

Regards,

A.J.

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…it doesn’t go to senior management in most tech companies, after what they get in the IPO. It’s how the company lures new bright young prospects to come work for them (as I understand it).

It does go to senior management as well, and often at higher multiples. For instance, Elon Musk gets paid only minimum wage - he’s rewarded with stock based on company performance (http://fortune.com/2016/04/19/elon-musk-stock-option-milesto…). Note that while he earns a ton this way, since he only earns it based on objectives obtained, I think it’s fair.

When Steve Jobs returned to Apple as interim CEO, he went to the board to get option packages for his top people at NeXT because he thought he’d lose them. He also worked to get his own compensation up. In his testimony on a case related to board meeting fraud, he talked about using stock to retain people that he thought would otherwise decide to start, or at least head up, their own companies (https://techcrunch.com/2009/04/25/steve-jobs-on-the-value-of…).

As a small tech start-up, the only way you get the really talented people to work for you instead of a more established and secure company with higher salary, better health and time-off benefits, AND to get them to work far more than normal hours is to give them a stake in the success of the company. The best way to do that is usually SBC.

When I hear people rile against all SBC as a rule, I’m glad they’re not actually running the companies in which I’m investing. I don’t believe Google or NetFlix or Amazon would have become as successful as they have been if they didn’t reward their high performers with SBC. It’s kind of like saying you don’t want Tom Brady because you have to pay him too much (OK not quite since he doesn’t get paid based on wins, but you get my idea that it’s a bad plan to be cheap with compensation in a business where the quality of the talent varies so much and affects the bottom line so much).

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Yeah, I hate the stupid things.
Anybody sane agrees with me.

???

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What’s important to me as an analyst is determine if management (or pundits) are hyping a stock.
One way to pump your stock is to claim profits when the only path to those profits is to issue
more stock. It’s a shell game that some managements (and pundits) are expert at promoting.

Ears

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One way to pump your stock is to claim profits when the only path to those profits is to issue
more stock.

Ears, This thread has gone long enough, but I had to answer this. Didn’t you read the initial post on this thread? Issuing more stock is NEVER a path to claiming profits! Not under GAAP! Not under non-GAAP or adjusted! Issuing more stock doesn’t let you claim profits! Period! Never! Under no circumstances!

That’s not just my opinion. That’s reality. Here’s what I wrote originally to start this thread. I’ll repeat it for you, since you missed it (with a tiny bit of editing for clarification):

How can people have no idea of what the difference between GAAP and non-GAAP is all about?

Do these people actually believe that the company really had a cash loss, and then gave away stock grants, and magically that allowed them to show a profit??? How! What nonsense!

If a company has a non-GAAP profit but a GAAP loss, what that means in the real world, is that the company made a cash profit, put the cash in the bank, real cash, REAL MONEY, real cash!

Then GAAP comes along and says, “Well, but you paid stock based compensation. Yes, we know that that is accounted for in stock dilution and an increased stock count (which reduces earnings per share), but we, in our wisdom, decided to double-count it and make believe it was a cash expense, and that therefore you didn’t make that profit. Yes, we know the cash is in your account, but we decided to punish you for being bad boys by making believe it isn’t there and you never made that cash.”

But yes, they made a cash profit, and the cash is in the bank!

Now, let me assure you, I don’t like companies who dilute my stock hugely each year, and some I avoid them because of it, but I’m aware that these rapidly growing young tech companies don’t have a lot of cash and can’t afford to pay large salaries, and the way they get bright young tech people to sign on is to give them a stake in the company. That’s life.

Saul

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Saul, perhaps by shouting something you think your opinion gains more credibility? If Shopify
had to compensate their employees with cash rather than stock, “adjusted earnings” would show
a loss. You can try to disguise that however you want.

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In other words,

If your business has an operating loss, issuing all the stock options in the world won’t let you claim a penny of profit.

If your business has a cash profit of $100, issuing all the stock options in the world won’t let you claim $1 more of profit.

To simplify a bit, what non-GAAP or adjusted tells you is what the business actually made. GAAP makes imaginary (non-cash) adjustments based on changing accounting rules. GAAP rules are modified almost yearly, and the rules on stock-based compensation date from the 1990’s and the 2000’s. They were specifically adopted to punish the rapidly growing tech companies that needed to give their hires a share in the business, and the rules were opposed by the tech industry for that reason. (General Motors, etc, employees don’t count on a run up in the value of the company, they want cash payments, not stock).

Best,

Saul

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Stock options seem to me to be a nearly required part of compensation in the early stages of growth in order to attract the right people, but it seems to me that this should be less true as the company matures. It is one thing to have a plan buy which people can acquire more stock, if they really believe in the company, but another to be handing out stock options to the janitor.

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I’m agnostic as to whether stock compensation is right or wrong, or if it should be expensed
or not expensed. When analyzing a business I look at it both ways. It’s hard enough to analyze
a business without painting yourself into some ideological corner.

What I’m especially looking for is how management portrays their operations. If I see an
otherwise unprofitable business hyped as profitable, I certainly don’t believe that’s what
“the business actually made”. Those numbers that you think are “actually made” are based
on accruals, which are educated guesses. They are easily influenced and sometimes manipulated
by management. Think AudioEye, for a blatant example.

GAAP isn’t a valuation tool. The purpose of GAAP is to encourage organizations to report
comparable results – comparable from one firm to another, and within a firm, from one
period to another and from one line item to another. If firm A pays employees with cash and
firm B pays with stock, GAAP encourages a standard where both are comparable. If firm A pays
with cash in Year 1 and with stock in Year 2, GAAP encourages a comparable standard. If firm A
pays employees with cash and pays consultants with stock, again GAAP encourages a standard. It’s
either a misunderstanding or misrepresentation to say GAAP punishes anyone.

Ears

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The purpose of GAAP is to encourage organizations to report
comparable results – comparable … within a firm, from one
period to another and from one line item to another.

Ears, you must be kidding, right?

Let’s consider company ABC, which makes engines, and has some outstanding warrants. What would happen if some terrible news came out during the next quarter? For example, if a big new engine had a bunch of defects, or a new competing product showed up which was taking lots of their customers. Their their stock price would crash (for good reason!).

GAAP rules for repricing the warrants would mean that because the stock price plummeted, ABC would show huge (imaginary) increases in their GAAP earnings for the quarter!!! And this is from a system that is supposed to be giving the public a clearer idea about what is really happening at the company!

For those who wonder what their rational is, it’s: stock price down = obligation from warrants reduced = more GAAP “profit”.

Next quarter, problem solved, stock price up, GAAP earnings way down!!!

If you think that GAAP are the only valid earnings, and that Non-GAAP are just “cheating,” these were the latest PSIX quarterly results, at the time I wrote the Knowledgebase:

GAAP earnings: 68 cents
Adjusted earnings: 39 cents

Whoa! GAAP earnings much higher than adjusted? It’s supposed to be the other way around! How can that be? Because, as usual, GAAP has a lot of nonsense in it:

  1. GAAP was up because the stock price was down so they had to reevaluate the “liability” of their warrants downward due to the lower stock price. This gave more (imaginary) GAAP “earnings”. Adjusted earnings were the real, lower, earnings, what the company actually made! Adjusted is almost always what the company actually made.

(Note that if the stock price had been up, repricing of the warrants for more liability would give lower earnings. If you think that makes sense, well…)

  1. In addition, GAAP income included a non-cash gain resulting from “a decrease in the estimated fair value of the contingent consideration liability” recorded in connection with an acquisition. This also gave more (imaginary) GAAP earnings.

Now if you think GAAP gives investors a better idea of how the actual business did in the quarter, be my guest. As I said, it’s nonsense to me.

Saul

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The purpose of GAAP is to encourage organizations to report
comparable results – comparable from one firm to another, and within a firm, from one
period to another and from one line item to another. If firm A pays employees with cash and
firm B pays with stock, GAAP encourages a standard where both are comparable.

Except that they are not comparable. One is cash out of company assets and the other is pieces of paper that only influence the value held by the shareholder … and even will bring in money when the options are exercised.

For example, let’s take a ridiculously simple case. Year 1, boss guy gets 100K in salary, no options, and there is 200K in sales and 50K in other expenses, so the profit is $50K, no question. Then, in year 2, boss gets the same salary, $100K in options, 300K in sales and 100K in other expenses. So, from a cash point of view the company made $100K profit, a 100% increase over the prior year based on a 50% increase in sales. But, from a GAAP perspective, they made $0K profit, much worse than the prior year. How does that make sense since the options didn’t cost the company anything?

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GAAP is there to establish conformity in reporting. “Generally Accepted” standards. Whether it is “right” or “wrong” in any particular instance is not the point

In any case my reasons for holding most of my stocks are future based. No matter how you slice it and dice the accounting , most of it is past based.
Thus except for a few simple metrics I mostly ignore both GAAP or non GAAP. The closer most pros look at the accounting the more they may miss of the future, which leaves room for me.

Whether company earnings suffer (indirectly effecting stock price) or shareholders are diluted (more directly effecting stock price) it may tend to come to the same in the long run. But employees do have to be paid with something, so it’s options and/or cash. Shareholders are hurt by both, but not hurt as much as if the company had to fire all it’s best employees. Or they quit to go elsewhere because of low compensation.

In theory options align employee interest more with shareholder interest. IMO that is mostly theory. Except for perhaps small companies exhibiting lots of growth.

If a company rewards insiders too much by either salaries or options, buy something else.

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