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L.3 · INTERMEDIATE · 2 MIN

Stock-Based Compensation: The Hidden Cost

Many companies pay employees partly in stock instead of cash. This stock-based compensation (SBC) is a real cost that dilutes existing shareholders.

Quiz · 5 questions ↓

Three ways to view stock-based pay

PerspectiveSBC Is...Why
GAAP accountingAn expense on the income statementReduces reported earnings
Cash flow statementAdded back (non-cash expense)No cash left the company
Shareholder valueA real cost via dilutionMore shares = each existing share worth less

Why adjusted earnings that exclude stock mislead

Some tech companies report strong 'adjusted earnings' by excluding SBC. But if a company pays $1B in stock compensation, that is $1B of value transferred from shareholders to employees. It is real.

Compare stock pay to net income

Look up a tech company like GOOG or META. Check the SBC expense in the financials. Compare it to net income. Is it material?

Why free cash flow should not ignore stock pay

Free cash flow that ignores SBC overstates true owner earnings. Always check SBC as a percentage of revenue. Above 10% is a yellow flag.

Does adding back stock pay give true earnings?

A tech company reports $500M net income, $200M of which is stock-based compensation (SBC) added back to calculate non-GAAP earnings. Is $700M the true earnings?
Check your understanding

Sit with the ideas.

Company A reports $500M operating cash flow (which includes a $200M add-back of stock-based compensation) and spent $150M on capex. Treating SBC as a real cost, what is its SBC-adjusted free cash flow?

Why:
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Other lessons in this course.

  1. 01Accrual vs Cash Accounting
  2. 02Depreciation: Spreading the Cost of Assets
  3. 03Stock-Based Compensation: The Hidden Cost— reading now
  4. 04Adjusting Entries: Why Period-End Matters
  5. 05Revenue Recognition: The ASC 606 Five-Step Model
  6. 06Bad Debts: When Customers Don't Pay
  7. 07Inventory: FIFO vs. LIFO and Why It Matters
  8. 08PP&E Deep Dive: Four Depreciation Methods and Asset Disposal
  9. 09The Cash Flow Statement: Follow the Actual Money
  10. 10DuPont Analysis: Decomposing Return on Equity
  11. 11EPS and Dilution: The Most Watched Number on Wall Street
  12. 12Deferred Taxes: Why Tax Expense Differs from Taxes Paid
  13. 13Lease Accounting: The Hidden Debt That Isn't Hidden Anymore
  14. 14Straight-Line Rent: Why Escalating Rent Is a Level Expense
  15. 15Deferred Rent: The Liability Straight-Lining Creates — and Where ASC 842 Put It
  16. 16Prepaid Rent: Why Paying the Landlord Early Creates an Asset
  17. 17Lease Disclosures: The Footnote Behind Every Lease Number
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