Hungry: AMZN, EBAY and YAHOO are at bubble valuations -- the debate should be over whether or not they will deflate to valuation. I do not know of any meaningful valuation model that would suggest any support for current prices. I use the word "bubble" valuations because of the infamous claim that valuation does not matter when it comes to net stocks, since they have "unlimited opportunity" -- feel free to add your own favorite from the gallery of absurdity used to justify net stock bubble pricing. If we ever reach the point where reported earnings reflect reality, and if valuation models apply, then these should be ideal stocks to short -- in the long run. In the short run, the gross distortions in their pricing attract so much short interest that the stock is subject to short-squeezes and not entirely attractive. I am not short any of these stocks -- although at current prices I am very tempted indeed to consider it. Good luck. BTW, the passages on expensing options from the link you posted was very interesting, so I bounce it back to you now:
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<<All companies are required to show in annual financial footnotes what their earnings would have been if they had expensed stock options. Many tech companies hope that investors ignore the options issue and focus on profits excluding options. But Wall Street is starting to come around to Berkshire Hathaway Chairman Warren Buffett's contention that options are a form of compensation, have real value and therefore ought to be treated as a cost. The pervasiveness of options in the tech sector shows they're very much a substitute for cash pay.
During 2002, eBay issued 17 million options, equal to 5% of its shares outstanding, to reward many of its 4,000 employees. In contrast, many big companies keep their grants to 1% of shares outstanding. As noted, eBay's 2002 earnings would have been just 23 cents a share, against its reported 87 cents, if it had expensed options. That means eBay shares trade for about 400 times option-adjusted 2002 profit.
The option expense recorded in financial footnotes typically represents the cost of options issued over several years, as companies tend to amortize option expense over vesting periods of three to five years.
"If you take into account the options expense at eBay, it materially changes the economics of the business," says Ken Broad, a portfolio manager with Transamerica Investment Management in San Francisco. Broad, like many others, is enamored of eBay's business model but can't stomach the company's valuation because he has focused on option-adjusted earnings.
Some investors estimate option expense simply by taking the value of the 2002 grants, as measured by the Black-Scholes pricing model, and then deduct that amount on the income statement. If eBay's 2002 option issuance were treated this way, its costs would have risen by about $300 million, which would have cut profit by about 65%.
"If eBay doesn't cut options issuance, it's an extremely expensive stock," says Broad. The good news for it and other big options issuers is that they can reduce their grants — and may indeed do so once options expensing is mandated.
Yahoo's chief executive, Terry Semel, who came from the entertainment industry, is trimming his company's grants, saying earlier this year that they're "not a healthy way to reward people." Yahoo aims to limit its annual options grants, net of forfeitures, to less than 2% of its share count. That's an admirable goal, but their cost would remain appreciable.
Assume a 2% net grant this year and Yahoo's options costs would be around $100 million, roughly 10 cents a share after taxes and nearly a third of expected net income. And if Yahoo had expensed options last year, it would have reported a loss of 63 cents a share, instead of reported profit of 18 cents a share.
Amazon is among the few tech-oriented companies that have largely abandoned options in favor of restricted stock. This reflects the influence of its largest outside shareholder, the Legg Mason funds, whose top portfolio manager, Bill Miller, has been very critical of options. Restricted stock must be expensed under current accounting because it clearly is a substitute for cash pay and its value, unlike that of options, isn't debatable. Amazon, however, wants investors to exclude its restricted-stock grants when viewing its earnings because they are a noncash cost. Such treatment is rare outside the tech sector.
Amazon has yet to provide guidance on its restricted-stock grants for this year but they could total $50 million or more. The company will have to record just a portion of that as an expense because the issued stock will vest over several years. Many investors, however, simply deduct the cost of restricted stock in the year that it's granted because it's an ongoing expense. A $50 million grant would thus be equivalent to about 12 cents a share for Amazon, a sizable chunk of projected proforma net income of 32 cents this year. (Amazon pays no income tax because it has large tax-loss carryforwards.)>> |
