Clark - Thank you. My use of the word "nobody" was clearly in error. Many august personalities have attempted to quantify the cost to shareholders of stock options.
Now, this being acknowledged, how about you explain to everyone here the difference between my "bizarre" way of accounting and what is required by FASB (not GAAP, by the way)?
I'll take a crack at it and how about you explain to the thread where I'm wrong.
Options have a value, known in the future when they are exercised to be precisely the difference between what the security is worth and the strike price of the option. Whatever this turns out to be is a benefit to whoever holds the option, and a cost to whoever underwites the option.
Unfortunately, sometimes these options end up being worth zero. And it's difficult over ten years what the actual price of the stock will be, so figuring out what this actual value might actually end up being is rather a lot of bother.
The problem everybody had with options was knowing all this, but not knowing how to figure out a present value of that future value in a way that made sense.
Until Black and Scholes came up with their wonderful formula. Which is a way of ESTIMATING what the ACTUAL option cost will be and reducing this actual cost to present value, and then accruing this cost over the life of the option - ten years, in this case. So the "pro-forma" effect is a total of 1/10 of the absolute estimated cost.
Which is what is reported in that pro-forma statement.
For a lark, how about adding up ten years of accrued expected cost for one year's worth of stock option issuence and let the thread know what it adds up to. That's this year's option compensation cost. Next year they will add more to the pile. And the year after.
And then add to this all the existing options you know that are out there. Cost from prior years that have yet returned to roost.
Do this sum of sums and compare it to the $0.48 EPS growing at whatever percentage. Then come back and talk turkey about whether it's all accounted for in the diluted EPS figures.
My "bizarre" math is merely reflecting this same effect slightly differently. For example, looking at past ACTUAL costs. Kind of dumb using a formula that takes estimates as its inputs in order to predict what the past was. Particularly when one can compute it accurately it from known information. The company even supplies all the information for us.
And then there's the inconvenient bit in the middle. Black Scholes assumes a kind of steady state. Reality intrudes most unfortunately on the purity of theory. Like Bubbles and collapses kind of mess things up. Many many options underwater. Many more greatly above water. Feel free to make your purchase decisions based on what's going on in some theoretical world. Unfortunately we live in this one. All models are wrong, some are merely useful.
Resting on Black Scholes as the only way of estimating this pending difference between future market price and strike price is kind of risky. Often it is merely useful (even if "bizarre") to estimate what might happen based on facts at our disposal. In fact, my estimates of cost are conservative (this is a bullish board, I'd be crucified [as opposed to vilified] if I was caught inflating costs). For example, I have ignored the cost from any option with a strike above $20 and assumed that the share price will not go up from here. I could make matters worse by assuming Qualcomm is indeed a good investment and that the share price will go way up - thereby (a) widening the cost for the existing options, and (b) bringing millions of other options above the water line. But I have not.
For example, if all 82 Million outstanding well in the money stock options with average strike price of $6 are exercised at a market price of $32 then a benefit of 2.1 B$ will flow to employees. Do you dispute this? Kinda hard.
If you do not dispute it, then you might want to figure out where this 2.1 B$ is going to come from. The equity fairy?
And if you think employees are just going to wash their hands of 2.1 B$ worth of options just to make me be wrong... well, all power to you. And finally, if you think that $32 is too high a price from which to base option exercise... um... that's somewhat at odds with the idea that Qualcomm is a good investment.
And while you're navigating this prickly suite of facts and figuring out where the employee benefit is going to come from, maybe in parallel figure out what whoever it comes from is planning on getting in return during the same period, and how they are planning on getting that return.
So no it's not the same approach. Just the same set of principles. The value is equal to the difference between strike price and market price on exercise. Which value is a benefit to employees and a cost to shareholders. And happens in the future. Which we unfortunately have to estimate.
You might want to dispute this theory. Particularly the part about the cost being to the shareholders. Already we have some very vehement agreement that it's not being to the company.
Read my post to Peter about thinking like a shareholder and it might start to make sense. And if you still don't agree with me that it's a cost to shareholders, then answer this one question: cash flows to employees when they exercise their options. That's undeniable. It doesn't show up on the cash flow statement. Also undeniable. Where did it come from? Alan Greenspan? Goldman Sachs? The Equity Fairy? Indeed, have you discovered a free lunch?
And for each $1.00 that they get, where does each one of the 100 pennies come from? Can you follow the money back to its source?
I can. It comes from shareholders, hence my claim that they pay the cost. You disagree. Fine, then point to where else it came from and explain. Real cash. It's not like the cast of players is large. Your choices are: company, employees, shareholders, IRS, customers & suppliers. Feel free to suggest an alternative and show how it is so.
Then there's this claptrap about the historical dilutive cost of options: Neither you nor I know since we do not have the average strike price of the exercised options since that isn't reported in a 10-Q! But it is very close to break even since the average equity per share is $7-8 per share and so was the strike price you assumed for the options exercised in the last 2 quarters.
Pure bunk. It's all available for people who know how to read financial reports. For example, proceeds from issuing common stock in the last reported quarter were 52,350 M$. No shares were purchased. Shares went up by 2.5 M shares approximately. Approximate cost per share of $20.81 or so. So yes, we do know the average strike price, within pennies. Counter to your claim. You just have to know where to look. Sometimes it's hard, but at least in the 10-K you are given everything you need.
Secondly, dilution occurs when shareholders receive an amount per incremental share less than what that share is worth, inclusive of future earning potential. Which, supposedly is why we should pay more than $7 for a share of Qualcomm. If you've been paying any attention to this board whatsoever, we're supposed to be buying the future potential of those patents, not their asset value, for instance. Breakeven at $7/sh? I like your math. Can I buy your house? I promise you'll break even according to your criteria.
JS: When the option is issued there is an ESTIMATED cost. When it is exercised, there is an ACTUAL cost.
CH: Should be easy enough for you to show me where it shows up in the cash flow statement- something notoriously difficult to gimmick. So where is it?
No Clark, not easy. Impossible. Because it's not a cost to the company. We know the company doesn't foot the bill for these things, that's the part of my point we both violently agree on.
Won't ever show up on the cash-flow statement. It is a cost to SHAREHOLDERS, NOT THE COMPANY. Once you clue in to the fact that this is even a possibility, a whole vista on how to make or lose money on the stock market (or from others) begins to dawn.
I'm merely on the side of the argument that says we ask the company to report for shareholders, not just because we like lots of paper. And that stock option cost actually being paid by shareholders is something they might want to know. As opposed to guess at, or crawl around in the middle of various financial reports and retrofit. Incorrectly.
Your posts and those of a few others here are the strongest evidence I can think of to argue for such a reporting change!!!
And as for Qualcomm's equity having gone up so much, do you even have a clue what the line from their balance sheet: "Paid-in capital ... 4,901,967" actually means? Particularly in relationship to Qualcomm's total shareholder equity of 5,220,173???
You seem to think yourself expert on these things, how about explaining them to the thread.
Seems to me that this company's a real positive source of shareholder value, huh. It's managed to accumulate a whole 318 some-odd Million dollars in its entire life as a public company. Despite having been given 4,902 M$ by shareholders along the way. Not to mention how much went to insiders.
If Qualcomm was suddenly changed into a 5 B$ T-bill you'd be doing better than that. And if you were sharing one 770 millionth of that T-Bill it would only cost you about $6.36 for a slice. Not $32 a slice.
Actually, if you and 770 million buddies went and bought 32 dollars worth of 5.5% T-bill each, together you'd have 24,600 worth of shareholder equity earning you 1,355 M$ per year. Absolutely guaranteed, 100% net margin. Then you could hire some management and let them piss away 19,000 M$ on a whole cornucopia of strategic initiatives, and fritter away 1,000 M$ in miscellaneous expenses this year into "R&D" and end up very close to Qualcomm's EPS and Qualcomm's asset base. Except that your strategic initiatives would have to be worth something. And you could do this without the mess and bother of actually producing anything important or rubbing up against some Evil But Influential Cabal trying to wipe you off the map. And if next year all you did was fritter away less or launder some of those investments back into revenues... well you could grow EPS by a huge amount. No worries. And you could do this quite some years into the future.
It's amazing what one can do to grow EPS if one has enough capital to start with.
There are lots of folks willing to buy companies that dilute themselves 3-5% per year and show absolutely fan farkin' tastic EPS growth, even "diluted EPS". But are in fact capital sinkholes for their shareholders when all flows of money are properly accounted for.
How about this. I'll form a company. You give me $32 per share. I promise to generate EPS of $0.48 this year and increase that at 15% for the next 15 years, and to save that away as guaranteed increase to shareholder equity and deliver shareholders the cumulative result. Or, up make up the difference from my own estate.
If only a few sign on, we'll do it all on paper and I'll pay out of my estate. I'll even put funds in escrow to guarantee the expected amount.
If enough people sign on, we can do it for real. Say a hundred thousand shares of this no-brainer company, I'll even hire Qveau or some other thread lawyer to draw up the papers. All legal and proper. I'm very serious.
I may issue a few stock options to myself between here and then, maybe dilute your interest by 2% per year or so as we go.
I give you a better deal on par with an investment in QCOM. And with Guaranteed 15% EPS growth. No strategic misadventures to pee away your returns. For 15 years, no less. Qualcomm would be hard pressed to do better.
How willing are you? I bet not very.
Yet you claim Bottom line, I will happily invest in a company that increases earnings and cash flow by, say, 15% per year while diluting the stock via stock options at a rate of 2% per year with a strike price equal to the issue date share price. You welcome not to, although it is a mystery why. A simple calculation shows that in 10 years the earnings will be up more than 200% while the number of shares will be up less than 30%. Still a very good deal for the shareholder.
AT ANY SHARE PRICE???
ROFL... exactly the retail investor sentiment that Goldman Sachs loves to market to. No concept of what something is worth based on future value of cash flows, nor any clue how to value it. The only thing that matters is EPS growth.
So pay today's market price 'cause EPS is growing?
You are right. I don't invest that way. I invest because it looks like I will get back more than I pay to play. Very simple. So far, mostly I've been right. And where I've been wrong, it's been because the economics underneath the model fundamentally changed, legitimately (but unexpectedly) - not because I bought a high-tech pig in technology poke.
John. |
