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Author: Chinwhisker Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 10413  
Subject: From the Fool on the Hill Archives Date: 10/7/2002 10:29 PM
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I've read the statement made a number of times ... "Where was the concern over ESO expense 2 or 3 years ago?" Answer, right here;

http://www.fool.com/eveningnews/foth/1999/foth990507.htm

TMFGump May 1999

Before closing out this series, let me point out that stock options are a very effective tool for companies to use in attracting and motivating employees. In addition, they provide a means for small, upstart companies with limited cash resources to attract superb recruits. My only beef is that they are not accounted for on the income statement, which leads to distorted financial reporting. Investors utilizing profitability and valuation measures in their decision-making process should not ignore this compensation expense.

The last of a 3 part article.

Chin
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Author: TMFOtter Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7973 of 10413
Subject: Re: From the Fool on the Hill Archives Date: 10/8/2002 10:24 AM
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Chinwhisker -- You may have missed this column in which I detailed ALL of the Fool ESO arguments from 1998-1999:

Stock Options: Now You Care? April 2, 2002

http://www.fool.com/news/foth/2002/foth020402.htm

It seems that when investors were getting wealthy by holding stocks of almost any flavor stock options grants were of little concern. Now that the stock market has turned sour, investors are no longer very patient with insiders getting multi-million dollar stock options grants. Well, it's about time. The Motley Fool has been howling about this for several years.

Best-
Bill Mann

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Author: TMFTom9 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7975 of 10413
Subject: Re: From the Fool on the Hill Archives Date: 10/8/2002 10:52 AM
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Hey Chinwhisker,

You will find a Motley crew of opinions here from writer to writer. That's one of the joys of working here. And also consider the time Warren was writing -- long before a groundswell existed for expensing. We were out in front of that one for years.

But we don't disagree. Today's follow up Rule Breaker column makes it clear that we use the 5%/3% guidelines precisely because there is a case for the view you cite from Warren. 5% annual ESO grants for newer, developing companies; 3% for established. That 5% is 67% greater than 3%. ;-)

And I also think there's a case that expensing options and the percentage of grants are not linked, but I haven't spent a lot of time on that.

The column will be published later this AM/around lunchtime.

Thanks for posting.

Best,
Tom9


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Author: Chinwhisker Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7982 of 10413
Subject: Re: From the Fool on the Hill Archives Date: 10/8/2002 7:30 PM
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Chinwhisker -- You may have missed this column in which I detailed ALL of the Fool ESO arguments from 1998-1999:

Hi Bill,

Thanks for the reply. I'm afraid I did miss this earlier, but it has only been recently (10 months ago?) that I got into the evaluations of the companies far enough to consider the "real" expense from ESO. I have read your articles, and am proud to be a member of a community that doesn't mix words and will state the truth about investing without affirmation. The reason for drawing attention to TMFGump's post is that it was the earliest I found where the actual expense between the price paid for exercising the option and the price of the option was stated as the "real" expense.

The reason for searching for these articles, is that when discussing it with other Fools on the boards, I often would read in a reply "Where was the concern over ESO X years ago. From these articles, I can see that the concern was there, and like you stated, until the market turned sour, no one was listening.

Still, to date, few realize the real expense of ESO. I, myself, didn't have the good sense to just type ESO in the little search box until after I had studied on my own for some 10 months the effects of ESO expense. Sure wish I had. :o)

Thanks,

Chin

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Author: Chinwhisker Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7983 of 10413
Subject: Re: From the Fool on the Hill Archives Date: 10/8/2002 7:53 PM
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But we don't disagree. Today's follow up Rule Breaker column makes it clear that we use the 5%/3% guidelines precisely because there is a case for the view you cite from Warren. 5% annual ESO grants for newer, developing companies; 3% for established. That 5% is 67% greater than 3%. ;-)

Hi Tom9,

Great to hear from you as well. I agree with your 5% and 3% upper stop limits. At first, I disagreed, but after giving it a bit more thought, as a dilution effect this is a good, quick guideline to set a limit on.

And I also think there's a case that expensing options and the percentage of grants are not linked, but I haven't spent a lot of time on that.

Believe me, I have. The percentages aren't, but finding the real expense for a period from exercised options is easy. Price of option minus price paid minus tax benefit. The problem with granted options (in a current period)is self created. We want to believe we can predict the future effects of the options granted, or outstanding options. I like the Warren Buffet 1/3 rule for granted options. Even though no one year's worth of data isn't going to efficiently account for the rotating effects of options granted in the past, the one year granted options times 1/3 adjusts for acquisitions and mergers quite well. The most recent year will account for the ESO that has been adopted from any companies the parent company has acquired or merged with. The most current years worth of data on granted, and even exercised options, should give a close enough figure to what the total options outstanding are, and looking at this as a percentage to total shares shouldn't be any different.

The 1/3 rule of thumb accounts for the expense in an intrinsic value manner. My best example for determining this would be to bring the stock price of the company 6 to 7 years on average for the exercise price into the future at a 10% to 11% average growth rate. This would put the stock price at double what the current stock price is. That means the employee will have to pay approximately half the share price for exercising the option. The employee then has to pay tax on the spread, and the company receives a tax benefit. For the company this tax benefit on average will be around the standard 35% tax rate. The fact the employee paid for half the share price puts the companies expense at half. The tax benefit which equal close enough to 1/3 reduces this expense to 2/3 the company expense, or 1/3 the actual share price. Discounting the 1/3 expense in the future by a discount rate the same as the growth rate will put the actual expense for the option granted today at the same 1/3.

From this expense you would reduce your beginning adjusted earnings or FCF by. From that, you would further adjust the expense by the growth rate of earnings in your DCF calculations.

OK, here I am trying to tell you something you probably know more about than I ever would. You know how it is, you learn a little something and want to tell everyone. :o)

The point is, determining ESO expense into the future is no more difficult than determining share price into the future. The percentages of outstanding shares dilution doesn't reflect the effects on earnings, but does reflect the effects on shareholder's equity.

I'll shut up, and head toward your follow up now.

Thanks go out to you, Bill and the other TMFs for sharing your thoughts, and keeping the credo "Learning Together" true.

Chin

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