Message Font: Serif | Sans-Serif
No. of Recommendations: 46
At BRK's 2000 annual meeting, I asked a question regarding valuing stock options. Warren's short-hand answer was that for a company paying no dividends and issuing 10-year at-the-current-stock-price options, one should subtract from net income 1/3 of the value of multiplying the # of options granted times the exercise price.

I was glad to hear that this was roughly the same answer that I was getting with my own calculations. I like to think of employee stock options as basically giving employees an interest-free loan to buy the company's stock. But even better than an interest-free loan, if the stock goes down, the employee can subtract from the principal due, the decline in the stock (therefore the employee can never lose money!). For this never-lose-money feature, there is usually a vesting period. I figure these features roughly balance out.

Let's go through an example. If a company lends you $5,000 for 10 years to buy 100 shares of stock at $50, what is the value of the loan if interest rates are 7%? Well, at 7% interest, $5,000 would grow to $10,000 in 10 years. At which time you pay back the original $5,000, and you are left with $5,000 in profit. But, this $5,000 profit received in year 10 has a present value of $2,500. Therefore, the company is giving you $2,500 in today's dollars. If the company had paid this in cash, it would have reduced reported gross income by $2,500, or net income by $1,625 (35% tax rate assumed). What do you know, $1,625 is Warren's short-hand answer (1/3 of $5,000)!

An associate of mine went through and tabulated the option costs over the last 4 years for about 145 well-known companies. It is very interesting to see the trends in place at certain companies and how reported income is affected. Below is a link to a work-in-progress spreadsheet that we've developed. Enjoy.

Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.