There’s a lot hiding under the onionlike layers of some companies’ earnings.
Many companies, especially tech businesses, ask investors to rely on non-GAAP, or adjusted, profit to evaluate results. But ignoring standards comes with its own perils especially with stock-based compensation, which can be both a burdensome tax expense and, via creative accounting and share buybacks, can inflate free cash flow, another non-GAAP measure.
There’s nothing wrong with asking investors to use nonstandard measures, but it’s worth keeping in mind when evaluating a stock, especially highflying tech names. That’s why Barron’s screened the NYSE and Nasdaq companies with over $50 billion in market value for those doling out the most stock compensation as a percentage of revenue.
Stock compensation is typically used by startups to keep cash burn at a minimum, and theoretically handsomely reward employees if there is a liquidity event such as an acquisition or initial public offering.
After an IPO, a typical tech company’s first quarters of public life will nearly always be characterized by large losses caused by employee stock vesting, which translates to the stock compensation line item in the financial statements.
Equity is used by older businesses too as a means of giving employees additional compensation and retaining staff. If options vest every year, it’s a reason for employees to stick around for another. There’s also something to be said for letting employees share in the company’s upside.
In the case of
(ticker: SNAP), which ranked at the top of the screen, the company’s third-quarter adjusted earnings reveal that it excludes from adjusted earnings a $192.1 million charge for stock-based compensation, or roughly 28% of quarterly sales. That’s the vast majority of its GAAP net losses. Snap has been public for more than three years, and is still paying out large amounts of stock. On an annual basis, stock compensation is about 40% of its revenue.
In its earnings call, Snap executives said that its stock compensation continues to go up because it keeps hiring more people. On a per person basis, the company has been giving out less stock than it once was, according to Snap CFO Derek Andersen. That suggests it’s still expensive for Snap to bring on board new people amid the Covid-19 pandemic, but not as costly as it once was.
*Percent change from initial public offering price.
(UBER), which came in second, went public during its latest full fiscal year, suggesting that its stock payouts will decrease as time goes on. For its second quarter this year, it recorded a stock compensation expense of $408 million, which amounts to about 7% of its revenue for that period.
(SNOW) went public just weeks ago as well.
Software companies dominate the rest of the list. Businesses such as
Zoom Video Communications
(VMW) all offer various forms of enterprise software or software as a service. While classified as e-commerce companies,
(SHOP) and similar China-based
(PDD), build software and aren’t in the same business as
(AMZN). Many software companies, analysts, and investors rely almost exclusively on non-GAAP earnings as a measure of success.
Ostensibly a chip maker,
(AVGO) also runs a sizable enterprise software unit, which could explain its rank in the screen with 9.7% of revenue devoted to stock compensation. Despite its reputation for semiconductor expertise,
(NVDA) maintains a sizable code base, both to power its cards but also to optimize how they run in videogames, data centers, and in cars.
Of the companies listed in Barron’s screen, only
(VRTX) isn’t a tech business. The Boston-based company has been operating since 1989 and focuses on developing and manufacturing small molecule drugs for serious diseases such as cystic fibrosis, cancer, and viral infections such as the flu. Analysts who cover the stock generally think favorably of it, setting 19 Buy ratings, seven Holds, and no Sell ratings.
As with any screen, it’s a place to start your research, and may offer a reason to examine the financial statements a little more closely.
Write to Max A. Cherney at email@example.com