Stock-based Compensation Treated as a Cash Expense

CFA General
#1

Just came across a 2014 Damodoran blog advocating against adding back stock-based compensation when calculating cash flows for a DCF model. His logic is that compensation with stock is akin to selling stock in the market and paying out the cash.

What is the CFAI / CFA exam’s position on stock compensation when calculating cash flows (a source would be awesome)? What have you guys seen done in practice?

Thanks!

#2

I don’t have an official source but if that compensation would need to be replaced with cash comp as a private company than I would not add it back.

#3

Thanks Chad, can you elaborate a bit? Domadoran’s argument centers around shareholder dilution. Are you saying you think this is more relevant in a private company where perhaps the shareholder base is more concentrated? Trying to get a handle on your line of thinking.

#4

Adding it back to cash flow is treating share based comp as something that goes away if you take the company private, similar to a non-recurring charge. My opinion is not based on dilution, but the fact that the management team is getting value from their share based comp so they will need to be paid another form of compensation if you take the company private. In a nutshell, that expense is not going away if you buy 100% of the company.

#5

i usually use fcf when i dcf and a lot of companies add back stock based comp because its a non cash. but personally, i feel that just because no cash was paid, it should still reduce fcf because of damodaran’s logic. it is a real expense, if you choose not to pay them that in cash or stock the employee will leave. lol so yea adjust for it always no matter what, whether it is private or public.