If a business has $10 in BVPS at Year 0, and $10 in BVPS in Year 10, and $10 in BVPS in Year 100… isn’t that share really worth $0 in Year 0?

If a company issues stock to investors (instead of to its employees), and pays its employees with the cash from that issuance (instead of with stock-based comp), isn’t there both an expense and dilution? Is that double-counting?

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Posted by Peter Lewis (Questions: 1, Answers: 2)
Asked on June 26, 2020 8:10 pm
I think that it is double-counting. He says as much in the post I believe: "In short, not only do I not have a problem excluding stock comp so long as the cost is accounted for in the share count, I think that including it while simultaneously blowing out shares is indeed double counting."
(MoS at June 28, 2020 12:37 am)
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Thanks Boolean. Let me try to summarize in bullet point format what I hear you saying:
-The cash compensation is an expense.
-But, that expense is captured in the rising share count.
-If shares are issued at intrinsic value, that doesn’t alter the per-share value, and is equivalent to using cash on the balance sheet to pay employees.

But here’s the conundrum, I’m facing:
-A company is making $10mm prior to their employee bonus program.
-The company has 1mm shares outstanding.
-All investors agree that the shares should be worth 10x earnings.
-The company is trying to decide whether to pay the annual $2mm employee bonus with 1) cash on the balance sheet or 2) cash raised from share issuance.

Scenario #1: Pay with cash on balance sheet
Company reports $8mm in income (after the bonus) or $0.80 per share and stock is valued at 10x or $8/share.

Scenario #2: Pay with cash from equity raise (at $8/share, issue 250,000 shares to raise $2mm)
In this case, I don’t worry about the bonus expense because the increased share count captures that expense. Thus, income is $10mm on 10.25mm shares or $0.98/share. At 10x, the stock is worth $9.80.

Which is the correct fair value… $8.00 or $9.80?

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Posted by Peter Lewis (Questions: 1, Answers: 2)
Answered on July 6, 2020 2:54 pm
LEt me jump in guys!…just want to point out that you\’re asking is a different question than the double counting question, so you are moving the goal posts here….But to answer your question, imo the cleanest way to get at intrinsic vlaue is to just use a liquidation scneario plus math and common sense…..after 10 years in #2, shareholders collect 80m in profits divided by 10m shares or 8 per share. in #1, shareholders collect 100m of profits divided by 12.5m share, also 8 per share…..the values diverge over short or longer liquidation periods is share issuance at 8 can be either accretive or dilutive to value per share depending on when you liquidate….if you liquidate before year 10, it\’s accretive and so vlaue per share in scenario 1 is higher than in scenarnio 2 under that assumption….if you liquidate after year 10, it\’s the opposite…but this is a matter that has nothing to do with the original double counting question.
(SneakyPete at July 6, 2020 10:52 pm)
Thanks SneakyPete. I agree with the math. Here’s the issue I have: valuation commentary / analysis overwhelmingly relies on the use of multiples (either on current/future year results, or the terminal value in a DCF), as opposed to the example you provided of a cash build-up, then liquidation event. They don't consider the PERPETUAL share dilution required to fund an expense, but instead use the STATIC diluted shares outstanding, whether that be the current count or the terminal year count. I was hoping to keep this conversation simple by laying out this comparison and arguing that they are economically equivalent: Scenario #1: Step 1: Company issues shares to investors Step 2: Company uses cash proceeds to pay employees Step 3: Employees receive cash and investors own shares Scenario #2: Now invert Steps 1 and 2 and you end up with the same result in Step 3. Step 1: Company issues shares to pay employees Step 2: Employees sell shares to investors Step 3: Employees receive cash and investors own shares Now I suspect that most of us would scoff at the idea that in Scenario #1 we shouldn’t treat a cash payment to employees as an expense (or a cash payment to a vendor, lenders, or the IRS for that matter) because “it’s picked up in share count.” But, when we move to Scenario #2, which is economically equivalent to Scenario #1, we get all confused. It’s probably better for me to reference a 3rd party on this topic and just move on: https://accountancy.smu.edu.sg/sites/accountancy.smu.edu.sg/files/accountancy/pdf/Symposium/Paper6a_SanjeevBhojraj.pdf If you want to cut to the chase in this paper, see the section entitled "The Simplified Math of Stock Compensation and Cash Flows."
(Peter Lewis at July 7, 2020 1:57 pm)
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Thank you everyone for the help. I am still struggling with this and hope that you can clarify it for me just one more time.
Step 1: Public company sells shares to investors.
Step 2: Company uses that cash to pay employees.
Step 3: Employees receive cash.
So, I need not consider that cash compensation as an expense since the share count has increased? To do so would be overly punitive because it’s double-counting?

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Posted by Peter Lewis (Questions: 1, Answers: 2)
Answered on July 2, 2020 12:52 pm
It is an "expense" but that "expense" is implicitly captured in the rising share count. Assuming share issuance itself isn't accretive or dilutive to value, issuing shares and using the cash to pay employees is economically equivalent to simply using the cash on your balance sheet to pay employees. Issuing shares and using the cash to pay employees neither adds nor subtracts value in this case. The value per share realized by shareholders would be the same in both cases.
(Boolean2 at July 2, 2020 8:37 pm)
Post-Script: if you are not reporting profits on a per share basis, then you should subtract the stock compensation from the income statement (Scuttle makes this point already). For Example, if I report $10MM in cash profits and then I give everyone a raise of $10MM by giving them shares, it would be disingenuous to say that my profits are $10MM. I would say my profits are $0MM. However, when you are looking at things on a per share basis, the cost of the SBC should either be in the numerator or the denominator, but obviously NOT BOTH.
(Boolean2 at July 2, 2020 8:44 pm)
Private answer

Including both SBC expense and increasing the number of shares is double counting. Pretty easy to grasp. Just think about it. If you increase the shares every year and keep your cash profits constant, your denominator eventually gets so big that the value per share converges to 0. You don't increase the shares AND also include an additional cash charge for the shares you just issued. That makes no sense.

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Posted by Boolean2 (Questions: 1, Answers: 3)
Answered on July 1, 2020 11:44 pm
yes, Boolean2 is right. if i issue shares and use the cash to pay employees that is a cash neutral event for the company that is accompanied by a rising share count. if you do this enough times and assuming cash flows stay constant, then the value/share eventually gets close to ~0. the rising share count explicitly takes the cost of stock compensation into account. you would not punish the company twice by also including a cash charge for those issued shares in the numerator.
(scuttleblurb at July 1, 2020 11:59 pm)