Can Stock-Based Compensations affect investor returns?
Many companies proudly announce: “We returned billions of dollars back to shareholders via buybacks”.
What’s left unsaid: How much of those billions actually reduced the share count?
And how much was used up to offset dilution due to Stock-Based Compensation?
What is meant by Stock-Based Compensation?
Stock-based compensation, sometimes known as equity or share-based compensation, is a practice in which companies supplement employees' cash compensation (salary and bonuses) with shares of ownership in the business. It's most commonly awarded to employees through stock options or restricted stock.
How can it affect investor returns?
Let's understand via an example.
Consider an MNC named 'A'. Let A have $2B Free Cash Flow over the next 12 months. Currently, let's assume it's worth $100 in share price, and there are about 500M outstanding shares.
This puts the market cap of the company at $50B, 25x multiple of FCF. Fair enough.
Now if it invests the entire $2B into share buyback, it can retire 20M shares ($2B/$100), which roughly corresponds to 4% of existing shares.
Now, if 'A' has a 2% dilution due to SBC, half of the buyback will go towards this dilution buyback. Hence effective buyback would constitute half of 4% — which is 2%. This is the buyback that is called, money returned to shareholders. At this stage, the market cap is 50X and not 25X of the FCF.
Sometimes, companies buy back at even higher prices, pushing this multiple even higher.
Effectively, can hamper your returns, by buying expensive.
Remember, it's not just buying quality, but also the timing that matters.
1000 of the best analyst can buy the same company, however, returns for all will differ based on the timing of buying and their holding periods.
Cheers!
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