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Strategies & Market Trends : Value Investing
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To: Don Earl who wrote (14047)3/1/2002 12:08:53 AM
From: James Clarke  Read Replies (3) of 78673
 
<<I guess I still don't follow the reasoning that options should be treated as basically what amounts to a cash charge against EPS. Options already affect EPS in the form of dilution and taking a second hit on some theoretical pricing model doesn't make sense to me.>

You are correct later in your post that the biggest problem is what value to use, what is an option worth not knowing the future and any smart value investor will tell you a Black Scholes theoretical valuation is garbage.

But the reason this is THE MOST IMPORTANT accounting distortion is twofold:
1) the scale - EVERY company does this. Its rare now to find a company with less than 5% of its shares outstanding diluted by options and issuing less than 1% more a year. Most I look at its 10 and 2. 2% a year dilution given that long term returns from capital appreciation are in the order of 6% is a HUGE number.
2) Income statement accounting is based on expenses being matched with revenues. Saying options show up in dilution doesn't cut it, because that shows up years later. Take a very clear example. I got paid last year. That showed up on my public company employer's income statement. I also got bonuses. That showed up on its income statement. (Don't worry, I'm not even a rounding error!). But they also gave me options. That was something of value paid to me for work I did last year, but it shows up nowhere on the company's financial statements. Whats the difference bewteen that and cash compensation IF THE INCOME STATEMENT IS SUPPOSED TO REFLECT WHAT IT COSTS TO COMPENSATE EMPLOYEES FOR THEIR SERVICES. Thats the problem.
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