Paul Cerro's avatar
$26.8m follower assets
SBC is a scam to adj. EBITDA and you're getting diluted
Stock-based compensation (SBC_ has gotten out of control with some companies that utilize the line item top boost adj. EBITDA for profitability but can also dilute you.

Prime example is $TWTR. Market Cap >1.5x since IPO while price only up ~2% in the same time

The link below shows this weeks "Chart of the Week" for the following names

The numbers are quite shocking. If you're interested in receiving content like this, hit the subscribe button (it's free!).

sam stribling's avatar
@paulcerro would you enlighten me on this a bit? What is SBC and MC?
Paul Cerro's avatar
@strib Sorry I was limited to my tweet characters so I needed to shorten things. SBC = stock-based compensation (employee shares/options) and then MC was market cap. Fixed both in the above.
sam stribling's avatar
@paulcerro ahh gotcha thanks! So many acronyms lol
sam stribling's avatar
So is the moral of the story that in the adjustment process they are excluding stock based compensation (which as you stated is super high) to make their earnings (adjusted) look better? If so sneaky sneaky
Paul Cerro's avatar
@strib exactly. by excluding the cost of SBC, the numbers look better because while it's technically not a "cash expense" due to GAAP rules, it's still an expense that has repercussions. so when ppl look at adj. EBITDA numbers, you really have to make sure you know exactly what's being added back
Edmund Simms's avatar
Respectfully, I think calling SBC a scam is overstating the case. Also, share dilution does not decrease the value of existing shares. But I certainly agree that adj. EBITDA is a problematic metric, and executives claiming you should ignore SBC as an expense are deceiving investors and probably themselves.

Have you come across any companies that report non-GAAP adjustments that you think are beneficial to understanding the underlying economics of the business? That's a management I could get behind.
Paul Cerro's avatar
@valuabl Headline grabber. While I do think SBC is a great way for companies to attract talent, an abuse of SBC can cause problems. $TWTR for example gives their employees RSUs but while it doesn't cause a decrease in the "value" it does effect all other mechanics that trickle down to price which is exactly why it hasn't moved in nearly a decade
Edmund Simms's avatar
@paulcerro I'm sorry, I don't know what you mean by 'abuse of SBC'. Would you mind elaborating on that?

Consider these three equivalent scenarios:
  1. The company issues shares to an employee (SBC). The employee sells them in the market and keeps the cash.
  1. The company issues shares, sells them in the market, and gives the cash to the employee.
  1. The company pays the employee cash.

Ignoring tax implications and any gap between the value and price of the shares, all three paths will have the same effect on the value of existing shares.

Perhaps I'm missing the core point you're trying to make?
Paul Cerro's avatar
@valuabl perhaps I'm misinterpreting your definition of value?

My main point is that companies that want to attract top talent and retain them but can't pay in cash compensation usually do a hybrid approach. Cash salary + SBC.

Some companies have been issuing more SBC to be competitive in this market which when they do get executed dilutes ownership of existing shareholders by increasing the number of shares outstanding.

The balance between shares on the market and price is very delicate. That's why companies buyback shares to financially engineer how much earnings each investor gets on a per share basis which bumps up the price. Same effect happens in reverse when SBC gets issued in mass. More shares to attract and retain talent leads to price getting negatively effected if growth can propel it past it's negative effects.

That's why I showed the visual of $TWTR above as reference
Edmund Simms's avatar
@paulcerro Thanks for explaining!

Whether you pay employees in cash or shares, the value of the equity doesn't change unless they're producing less value than they receive or the market price of shares is different to the intrinsic value. It's the same thing the other way, buying back shares doesn't increase the value of equity.

Here's an example I put together to illustrate:

I hope it demonstrates what I mean. It's a fascinating topic.
Fat Baby Funds's avatar
$TWTR is a little more complicated because valuation was crazy. Fcf + SBC seems like a good way to go for me.
Paul Cerro's avatar
@fatbaby FCF doesn't matter when so many shares keep hitting the market every quarter. Valuation gets directly effected no matter how you cut it. Until they can get growth higher than the rate they're issuing shares, this trend will continue
Fat Baby Funds's avatar
@paulcerro That’s why you factor in SBC. FCF less SBC is what I look at.
StockOpine's avatar
@fatbaby that is indeed a fair assumption. You at least somehow measure the future SBC impact. If we get it right though, @paulcerro ‘s point is that if SBC grows faster than FCF then you might end up overvalue the stock and potentially overpay for that.
Paul Cerro's avatar
@stockopine correct. Nothing wrong with SBC in general, only when it gets out of control does it pose a problem