Free cash flow …..

Remember the dot com bubble when companies argued that stock options and stock based compensation (SBC) were not business expense?

SEC and FASB pushed back and new accounting rules were introduced to value SBC as a legitimate expense (which it is). A bummer for Wall St and for growth companies.

But workarounds have been found and are being increasingly adopted and lapped up by uninformed investors and greedy Wall St bankers. Here are two examples of how SBC expense has been deflected to make companies look more profitable than they are.

1. Free cash flow – Increasingly investors look at FCF as a better valuation metric (which it is) and this is metric has become a mechanism to hide SBC expenses. Since SBC is a non cash expense it is always added back to net income which increases “Cash Generated from Operations”…..which increases FCF. The next step is to (lazily) apply a multiple to FCF to arrive at company value totally ignoring equity dilution from SBC.

2. Adjusted EBITDA: Several growth companies have defined their own operational metrics. In shareholder meetings they explain why they focus on these alternate metrics to measure business performance.

Almost always Adjusted EBITDA = Profits if hypothetically there were no costs of running this business. As Charlie Munger says “When you hear EBITDA, replace it with Bullshit”

Coming soon….examples of how some growth companies are leveraging these techniques to look more profitable than they really are.