Stock-Based Compensation (SBC) is integral to mainstreaming the corporate earnings confessional. It often leads to a lack of comparability in the ways in which businesses disclose their financial results. This practice, which includes expenses such as stock option awards to executives, allows companies to present two different sets of earnings: Generally Accepted Accounting Principles (GAAP) earnings and non-GAAP earnings. The consequences of this practice can have far-reaching effects on investor expectations and investment decisions.
In 2024, Alphabet, the parent company of Google, incurred an insane $23 billion in Stock-Based Compensation. This unbounded figure provides a look at the scale in which SBC is used in corporate America. As with restructuring costs, most firms lobbied for SBC to be treated as a one-off expense. It’s one that the majority of accountants feel should be lauded as a true business expense. The Securities and Exchange Commission (SEC) mandates that all U.S. public companies use GAAP when reporting their official financial statements. This includes critical filings such as their 10-K reports.
Even with these regulations in place, companies often will still report Stock-Based Compensation as a negative in their non-GAAP earnings releases. In fact, a recent analysis found the opposite to be true. Eight out of 10 firms in the Dow Jones Industrial Average (DJIA) announced non-GAAP earnings excluding stock-based compensation (SBC). This exclusion is not uncommon, and it significantly boosts earnings figures. Research has demonstrated that when SBC numbers are omitted, they on average exceed GAAP earnings by 31%. The median difference between non-GAAP Earnings Per Share (EPS) and GAAP EPS for DJIA companies remains a point of concern among analysts and investors alike.
For months, research partners Laura Griffin and John McInnis conducted in-depth research. They looked at more than 70,000 quarterly earnings announcements with SBC content from U.S. public firms from 2003-2021. Their findings underscore the growing trend among firms to present earnings that exclude SBC, raising questions about the transparency and integrity of financial reporting in the market.
First, investors have woken up to SBC’s dilutive effect on net income. Even when companies hide these costs off their balance sheets, investors still often call them into account in their valuations. Some exclusions are more controversial, though, as they account for what are essentially a type of long-term expense that can linger on income statements for decades. This poses a significant problem for investors looking for a digestible and straightforward representation of a company’s financial condition and operating results.