SBC-If it's not a cost, then what is it?

Stock-Based Compensation (SBC) has increasingly become a preferred method for companies to provide remuneration to their employees. Since 2011, total SBC provided by all companies listed on Nasdaq grew by a CAGR of 19%, amounting to USD 163B in 2021, from USD 28B

Although SBC may not be a direct cash cost to a company’s operations, it is an intrinsic cost that is often ignored by investors when considering a company’s profitability. The dilution of shares eventually impacts the return of existing shareholders. While it may be a charge on equity, in essence, it could be viewed as compensation to run the company.

Our research indicates that 5% (75) of all profitable companies listed on Nasdaq were only profitable in FY21 when adjusted for SBC. Five of these companies belong to the Nasdaq100 composite. When SBC is accounted for as a cost, these companies turned to a loss, leading to distorted valuations. Total SBC paid out in 2021 by such companies amounted to over USD 7.6B, elevating profits and developing a gulf between adjusted and actual earnings. The total market cap of such companies amounts to USD 303B.

Amongst the 1,644 profitable companies on the exchange, we found that there were 270 (16%) companies with SBC higher than 20% of their adjusted net income. The total market capitalization of such companies amounts to $3.0T. Adjusted for SBC, this basket of companies trades at a trailing PER of 38x. However, when treating SBC as a cost, the PER jumps to 68x, highlighting the inflated valuation SBC causes.

*The data analyzes 3,486 companies listed in the Nasdaq index that report in USD. Net Income and SBC data used is of FY21. Market Capitalization is as of 24/05/2022. All figures in USD Mn

**Data provided by Bloomberg alongside Vitality Capital estimates.