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The Stunning Truth About Stock Based Compensation

The Value of Stock Based Compensation

A lot of attention has been given to how much companies pay their employees in stock based compensation. The expense is marked down as an operating expense, but its non-cash. The argument has become heated as to whether stock based compensation is a smart use of funds to save growing companies cash, or if it’s an unfair use of shareholder equity.

Let's examine the companies that spend the most on stock based compensation -- some of the numbers are unbelievable.

Let's take all of the technology companies traded on U.S. exchanges with market caps above $30 billion and rank them by the amount they spend on stock based compensation for every dollar of total operating expense.

For every $1 Facebook (NASDAQ:FB) recognizes as operating expense, $0.24 goes to employee stock compensation. No other company other than China's Alibaba even pays out $0.10. As Facebook's stock continues to rise, the upside becomes less valuable. At a $330 billion market cap, employees no longer look to stock based compensation from Facebook and dream of a five-fold return.

The impact will soon be felt at Facebook as operating expenses for employee compensation will soon turn to cash expenses. We do note that Alphabet's Google comes in at number three, spending $0.10 out of every $1 in operating expense as stock based compensation. Apple, and Netflix all come in around $0.02.

This is a fascinating exercise to repeat for some of the midcap tech names. Here is the same chart, but this time we look at companies between $8 billion and $15 billion in market cap.

At the top of the list is the cyber security marvel Palo Alto Networks, and right behind it is Twitter. Both of these companies payout as much as Facebook, but the argument that the upside has far reaching potential is much more compelling given the market caps of $12 billion and $10 billion, respectively.

In fact, Twitter's stock based compensation has been a hotly contested topic but still remains one of its great recruiting tools. The risk here is that as the stock drops, lots of employee options become worthless and people may leave the firm, feeling that a large part of their compensation is no longer of value. This is what Silicon Valley refers to as "brain drain."

So is stock based compensation symptomatic of stocks that rise? Let's look at the stock returns over the last two-years of the top six (three from each market cap group) versus the bottom six (also three from each market cap group). We note that Alibaba is excluded because it does not have two-years worth of stock data.

It's a small sample size, but if you wanted to know why Twitter shareholders are so upset, look at that first table. Not only is Twitter the only one of the top six that shows negative returns, the rest have a minimum return of 35%.

As for the other group, we see a 50/50 split between positive and negative returns.

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The author is long Apple, Twitter and Palo Alto Networks stock. Thanks for reading, friends.

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