Silicon Investor (SI) -- The First Internet Community

STOCKTALK

We've detected that you're using an ad content blocking browser plug-in or feature. Ads provide a critical source of revenue to the continued operation of Silicon Investor. We ask that you disable ad blocking while on Silicon Investor in the best interests of our community. If you are not using an ad blocker but are still receiving this message, make sure your browser's tracking protection is set to the 'standard' level.

Technology Stocks : Dell Technologies Inc. -- Ignore unavailable to you. Want to Upgrade?

To: SecularBull who wrote (52189)	7/18/1998 7:20:00 PM
From: Chuzzlewit	Read Replies (1) \| Respond to of 176387

LOD, I disagree entirely. Because of the way accounting works, your method will not yield the desired result. For example, suppose a stock is trading at $100 per share but rises to $150 per share and falls back down to $100 at the end of the period. If the company repurchased 100,000 shares at $150 and then issued 100,000 at $100 there would be no effect on the P/L statement and there would be no effect on EPS, but there would be a net decrease in cash of $5MM but it would never be accounted for. If you don't believe me, check it out with your accountant. GAAP doesn't handle this situation properly. Employee stock options add several levels of complexity to the problem. First, because these are equity transactions their true cost is hidden. Second, because these transactions increase the number of shares they are dilutive. Share buybacks simply obscure the underlying problems. Every investor should be aware of this stuff. The effects are real and measurable, but the accounting standards serve to hide rather than illuminate. TTFN, CTC

To: SecularBull who wrote (52189)	7/19/1998 8:54:00 AM
From: Geoff Nunn	Read Replies (3) \| Respond to of 176387

LoD, I have to disagree with you concerning your statement: Chuzzlewit, what you need to focus on is quarter-to-quarter increases or decreases in diluted shares. PERIOD. Nothing else matters, and when you look at it in this way, there is no accounting shell game going on here. The number of outstanding diluted shares is all that matters. You seem to be assuming that "dilution" of shares is a well defined, observable entity. Unfortunately, it isn't. When a firm computes diluted shares, how does it do it? It takes actual shares outstanding and adds potential new shares represented by existing options contracts. This yields a prediction of future actual shares. The figure is then used to compute "fully diluted" earnings which firms report to shareholders. Unfortunately, the diluted EPS which the firm reports may have nothing to do with reality. Take the following hypothetical example. Suppose XYZ Corp. has 1M. shares outstanding. Assume it previously issued 3M. employee stock options, broken down as follows: 1. 1M. out-of-the-money . 2. 1M. slightly in-the-money 3. 1M. deeply in-the-money Now, let's assume the firm has total earnings of $2M. Its basic earnings are $2 per share, but what are its diluted earnings? To determine this, you must first determine "diluted shares". Should this figure be 2M., 3M., or 4M.? The problem with using 4M. is that this figure overstates likely future actual shares. Some of these options may very well expire worthless, especially those in category 1. Yet, it wouldn't be right to completely ignore category 1 either. Regarding category 2, a case can be made that these options shouldn't be counted. After all, if slightly-in-the-money options are exercised, the firm receives nearly full market price for the additional shares which are issued. In cases like this, the dilutive effect has little adverse effect on existing shareholders, and is akin to a purely capital market transaction. Regarding category 4, it is deeply in the money options which have the most adverse consequences on existing shareholders. Clearly, these options should be reflected in the dilution of shares calculation. How then do we decide what the appropriate "diluted shares" figure should be? I would suggest there is no meaningful answer to this question. Perhaps what we should do is follow the recommendation of Chuz and others: recognize that employee options have a cost, and this cost should appear on the P/L statement at the time the options are granted. The Black/Shoales options formula could be used to determine what an option is worth when it is issued. Moreover, the revenues which are generated when an option is exercised (i.e., the strike price which the employee pays) should also appear on the P/L statement. Employee stock options are a cost to the firm just as are salaries, medical insurance, etc. I see no reason why they should be treated differently. The current approach distorts reported earnings, perhaps wildly. Greg Maffei, the CFO at Microsoft, recently said in Business Week that "Our total options overhang is downright scary. It is a real concern over time, no question." If there is a good reason why current options-accounting shouldn't be scrapped, please explain what it is. JMO. Geoff