Kevin Koharki, PhD: What Stock-Based Compensation Really Costs -- The Billions That Never Show Up

0:00 Kevin, uh, you were featured in Wall Street Journal. You pointed out the issues we've been talking about today. Tell us what happened since and how it's already making a difference. >> Yeah, it's it's been really fun. Thanks for asking the question. So, this topic has bothered me for years and then eventually I got smart and I said, "Wait a minute. I always read the Wall Street Journal. I love John Wild's columns because John Wild was an analyst under Jim Chainos. He does the Herd on the street column. So, I reached out to him and said, hey, I got this idea. I think you might be interested." Long story short, he calls me like the next day. We spend the next couple of days talking about it, this and that. And I have no idea if they're going to run a story because the Wall Street Journal is really good with their integrity as like we will not tell you. We're doing a story. We'll talk to you. We'll learn and we'll send it to you after we publish it. Great. So, I'm with a client. I'm with a consulting client. I have to give a keynote later that day, which was awesome because I wake up 7 in the morning and I get an email from them. They ran the story and the story was on uh he decided to use meta. I had no say over it. I just showed him how things work and then he gave me he did some quotes this and that. Okay, that runs on Monday. uh Wednesday afternoon after close, Nvidia releases their earnings and I'm flipping through it and at the bottom of their uh adjusted earnings table, they say starting Q1 2027, which is right now, um we are going to change our disclosure policy and we're going to start including stockbased compensation in our adjusted earnings numbers. Now, I don't think they're going to go far enough. They're going to include the gap cost, the $30 in our $90 example, but it's better than nothing. It's a start. And so I'm kind of curious to see what else comes out of this. And so then John wrote another article. He posted on LinkedIn about it talking about Nvidia. And then I'm working with a couple of other publications right now because they they've tried to piggyback this, but they're getting it wrong. And they're they're big publications. They're Wall Street Journal like so. So this is definitely gaining momentum. And as John Wild, who I now consider a friend because he's just a really good reporter and he's a good analyst, he said, he goes, "You know, my goal with my articles is to change the discussion, you know, to to change the way people think." And I I think we've done that.

2:11 And that's why I really appreciate just being on your podcast and being able to talk about this because I think it's an important issue. I think it's something that people who are serious about fundamental analysis and value investing should should know about. So, it's been truly a pleasure doing this despite some of the vitriol. As I told you, you're just opening our eyes to something we haven't seen before. Some of us are more ready to see it. Some of us need a minute, but it cannot be unseen once you saw it.

2:37 >> That is the quote I hear of I hear that from I've heard that from Fortune50 CEOs. You they're like, I can't unsee this. And I'm like, yep. That's just, you know, you can lie to yourself if you want to. I just don't like doing that. [music] Welcome to Talking Billions. [music] We talk about big ideas, big inspirations, big topics. We take on the hardest topic of all, money. How to make it, save it, keep it. But our conversations lead us to an [music] even bigger question, what it means to live a rich life beyond money. My guests [music] share their practices, principles, and evergreen wisdom. I'm your host, Boguml Veronowski, author, TEDex speaker, and investment [music] advisor to wealth creators with patient capital and an infinite [music] investment horizon. I work with families and individuals who aspire to grow wealth over a lifetime and [music] generations through disciplined, thoughtful investments in durable quality businesses while giving money meaning. Join me on this quest to unear and share [music] the wisdom of the ages. Let me share with you the podcast program disclosure statement.

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5:34 Tenzing sponsored this episode to help us make talking billions better for you. Use code billions at sign up for an extended trial and 10% off. Check out Tenzing memo today. My guest today is Kevin Kohhari, MBA PhD. He's the founder of CE Consulting, which stands for capital allocation enhancement. He consults with, advises, and provides keynote speeches for some of the world's largest firms, Fortune 100 companies across various industries.

6:04 His specialty is developing employees and executives financial acumen. Kevin believes that CS capital allocation priorities can be optimized when employees understand and can communicate the financial value of their work. This serves to enhance organizational trust, culture, performance, and value. He's an expert financial analyst who has analyzed hundreds of firms over a 20-year career, including as an MA M&A analyst and is currently an associate professor of accounting at Purdue University. Kevin, so nice to see you.

6:36 How are you? >> Oh, good. Welcome. Well, thanks for having me on. It's a pleasure to be here again. >> So, Kevin is a good friend, a fellow Value Xer. He's been on the show before. So, if you're listening to it today, scroll back and find an episode from last year where we talk about a lot more than we're going to talk about today. But today is a very focused episode. I wanted you to come back and tell us about stockbased compensation, how it works, how we get it wrong, and how we can be smarter about thinking about it both as employees, executives, and investors. So, I want to start how did it come about? Stock-based conversation hasn't always existed. When did it start? What is it? How does it work? and then we'll dive into how can it be a good tool or a bad tool.

7:23 >> Yeah. No, for sure. I mean, when it started, I mean, it was definitely it was definitely sometime in the 1900s. It it really got it really got going in the 1990s, uh, in the dot runup. So, when you think about it, these back then it was stock options. Stock options were given to employees usually of small startup companies because they wanted to preserve cash and you gave your employees incentives to think and act like owners hopefully um and just partake on the upside, right? So, if you were if you were into it, let's say, uh, way back when, um, and you were just starting out, things like that, you gave your employees a bunch of stock options, or if you were Microsoft or any of those, you might have given your employees stock options because you said, "Look, we think the value of this company is going to be worth a lot more in 10 years than today, and we need to conserve our cash because we're young, we're a startup, or we're venture capital backed or whatever it is." And that was kind of the impetus for it. Um, and a lot of the accounting research has always said, well, look, it's it's meant to align incentives with employees, managers, and shareholders. And so when it started, I don't know the exact decade, but it definitely got it definitely got big uh in the 1990s. And back then, it wasn't expensed at all.

8:42 So, companies would argue that this is a non-cash expense. And so the only thing that uh companies had to do, public companies, was provide a footnote disclosure, basically saying, well, if we did expense this, this is what the expense would be. Um, and and we went from there. Uh, then the dot bubble blew up. You know, folks like Warren Buffett said, "Well, look, if it's if it's an expense, then it belongs on the income statement, and if it's not an expense, where in the world should it go?" So then fazby the financial accounting standards board came out with 123R back in 2002 2003 and companies started expensing these things. Now I was a I was in college that I was an undergraduate student and Buffett said like you know this really doesn't go far enough. Um and at one point I I read uh some discussion that he or Charlie Munger gave where he said you know despite the changes that have come about we still try to account for the real cost of stockbased compensation and I've been on this mission ever since. Uh [laughter] and [clears throat] then you know like you know life gets in the way you start doing other things whatever.

9:50 Uh, and then somewhere somewhere m 5 to 10 years ago, I I really picked this back up again when I was an assistant professor at Washington University in St. Louis and it started to click uh a little bit, but it took a while. But I mean, I've talked with executives of Fortune50 companies on this uh legal experts, tax experts, audit experts, compensation consultants that deal with this, Treasury Treasury staff. So, at this point, I have a pretty good understanding of how this stuff works. I was literally talking to the chief technology officer of a of a Fortune 100 company two days ago about his stockbased comp. Um, and he said he goes, "Hey, we need to set up more time and go through this." And it's just Bogamill. It's been years of me confirming how these things work, how the accounting for it works.

10:36 >> Um, you know, and and things like that. So that that kind of takes us full circle, I think, to where we are today. >> So in in steps at first people ignored it, don't show it anywhere. Then there was a footnote. >> Then we started to expense it. Where are we now? Like and how >> we are still at the we are still at the expensing stage. So what has shifted >> is that we've gone away from we we've gone away from stock option usage.

11:03 Companies still use it but not as much as they used to. And they're replacing it with restricted stock units and performance stock units. So you'll hear me say RSUs or PSUs today at Nauseium. I'll probably mostly focus on RSUs because they're they're pretty similar. or the accounting forum is the same. Um, but that's where we are. So, we still come up with a value for options or RSUs, PSUs. We put them on our P&L >> and that's it. So, we're we're still basically where we were back in 2002.

11:28 Just what we use options versus RSUs has changed. >> So, I'm I'm curious. It was an interesting incentive and a way to save cash for younger companies. It kind of makes sense when I'm listening to you. >> But it became something that people use across the board. I mean, if I find a company that doesn't have it. [laughter] >> Yeah. >> And we'll talk about Berkshire in a in a few minutes. It's rare. Like, people have to have it.

11:55 It's almost an obligation. You can't find Well, at least that's the belief. You can't find a good employee unless you offer it on and on and on. How did it become such a widespread phenomenon? I I don't I don't know how it did. I mean, I have my theories on it. Um and and my theories are because you have you have to understand where it's concentrated. So, it's not, you know, it's not like there's all these large manufacturing companies that are doing this uh in in droves. It's really focused heavily in the tech sector and it's really focused heavily on what we would call the MAG 7 or the MAG 8 for the most part with the exception of one or two. Uh and so it's concentrated in these gigantic companies that if we believe that this is really to incentivize employees to act like owners and we should conserve cash, these are not the companies that need to be doing this.

12:46 >> Yeah. >> But uh you know for whatever it is, it it tends to be concentrated in in the tech sector and it's just gotten huge within some of the world's most valuable companies and that where that's where the potential problem comes into play. So like this isn't something that you see done adnauseium at at most companies but there's a there's a cadre of them where this is a very significant issue which we'll talk about a little bit later.

13:13 >> What what's their incentive to do that? So on the P&L it looks in a certain way the cash flow gets affected. We'll talk more about it. But do you think they have to use it to really get the talent? like I'm trying to get to the bottom of it of the why why Y why why >> um the way that I think about this I don't think they do have to use it to get the talent and and a lot of that uh relates to how you end up paying for this no matter what happens this turns out to essentially be for the most part a cash payment to the employee by the company and there's going to be a lot of people that say no that's not right blah blah it's like they're not exactly wrong initially when I give you these things it's not supposed to be a cash payment, but the company has to make one of two decisions. They have to say, "Well, if it's not going to be a cash payment, then I'm going to give you bogeum, the rsus, let's say, uh, when they vest, you're probably going to exercise them.

14:09 They become shares. You sell them." And at that point, we've diluted our shareholders because those units have now become actual shares. And so, you're just going to sell them in the open market. So, that's one choice the company has. The other choice the company has is to offset that dilution. And that's where they start repurchasing shares. And a lot of these companies will say, I'm basically quoting at a minimum, we are going to repurchase enough shares to offset dilution from stock-based compensation essentially.

14:38 End quote. >> So if that's the case, they've turned it into a cash cost. So the employee is getting the upside of the stock. But what I what I mean when I say you you basically have to pay it in cash anyway because if the company is repurchasing the shares, they're spending their money, shareholder money to pay the employee in cash. So they don't have to do this. They could just pay the employee as a cash cash bonus or whatever it is. But then you'd have to argue, well, what what price should we pay blah blah blah because it's no longer tied to the stock.

15:08 >> That's where this becomes tricky. So, I I think a lot of companies do this because, you know, a lot of these software engineers or whatnot, some of this top talent, they want that runup in the stock price. They want to be able to benefit from that. I don't blame them. Um, if we didn't do it that way, then we'd have to say, "Okay, I'll pay you more today or we'll agree to some fixed price in the future that's higher than I would have to pay you right now." And that just opens up another can of worms.

15:35 So the the big catch even if they are buying back the shares is the the time the delay right you issue the shares they vest over time and you and I and the same way the CEO doesn't know where the stock price will be a year from now >> no matter how well they know the business they might not even know where the business will be in a year >> but think about three four five years right the stocks do triple and they go up 10x so when I look at that there's a certain risk that they're underwriting that they thought they pay somebody a h 100,000 but they could be paying a million.

16:09 >> Yeah. >> Why agree to that? Like why say yes to that? >> Mhm. So here's where it gets interesting to me as an investor. Uh and so let's walk through how this works first just mechanically and then and then we can get into it. So let's just say I give you Bogamill. Um I give you a 100 RSUs when the stock is at 30. Mhm. >> I'm going to I'm going to expense that 30 * 100 units. And usually these things will vest over a three or four year cycle. So let's just say 3 years. So we're going to expense this in thirds.

16:44 I'm not going to expense the whole $30 times 100 shares at once. We're going to do it in thirds. And the reason we do that in accounting land is because of the matching principle. Right? So this is literally the second thing that you would teach an undergraduate student after revenue. uh which is basically the expense has to match the revenue in the period that it's generated. So when I pay you Bogamill your salary or your bonus in 2025, that's easy because you work for me in 2025. I know that you the work that you put in generated some revenue for me for the most part in 2025. So we're matching it up with the stockbased compensation.

17:20 It was meant to delay that a little bit. And so you'll get the reward of this over time. And so for whatever reason, FASBY and the IASB, the International Accounting Standards Board, said, "Neh, you know, 3, four years is probably is probably a good amount of time, and that's it." And so we book that expense evenly over a three or four year period, whatever we're going to use. But now, let's say that at the end of the third year, the stock is at 90. Well, because it's an RSU, a restricted stock unit or a performance stock unit. As soon as it vests under IRS code, it's now a taxable event. So, you have to pay tax on it.

17:58 Well, if the stock is at 90, that's the value we're going to use. >> Mhm. >> So, you get the full value of the 90, so to speak, and it's taxable to you. So, what shows up on the P&L in this case is just the $30 times the 100 shares evenly over three years. That's it. that gap between 90 where the market price is when you decide to exercise and the 30 never shows up on the P&L. It's like it didn't exist. So that's the first problem. Now on top of that, this is kind of cool. My I'm geeking out on this a little bit. The $30 that we expensed over time, fine. It's in our SGNA. Let's say it's in our opex.

18:42 But the shares are also in the diluted share count >> because they are expected to vest and become live shares. So when I give you RSUs, it's hitting my diluted EPS twice. >> So that's interesting in of itself. But again, the $60 difference, the 90 to 30 doesn't exist basically. Now let's go to the statement of cash flows. Well, it is not incorrect to say that these are non-cash expenses when I give them to you because they didn't vest. You can't do anything with them.

19:14 So, I'm not spending any cash. But when they do vest and you bogeum decide to exercise, I have the choice of a as a company. We can either use the sell to cover method, which is you get the entire you get all the shares, you get the whole hundred, you sell them at 90, and then basically I'll pay the tax for you. uh I'll take it out of what you sold because again under IRS code this is payroll essentially by law I have to withhold tax on it. So you're going to sell your shares, you're going to give me a part of that and I'm going to pay the withholding tax.

19:48 >> Uh a lot of companies use what's known as the net settlement method. >> So in that case what's going to happen is when the 100 shares vest, I'm going to automatically cancel let's say 30 of them for tax reasons. You're going to get 70 shares times 90 bucks a share. I've cancelled 30 of them. And then me as the company, I'm gonna pay that your withholding tax out of my cash account. >> Mhm. >> So that's very clearly listed on the statement of cash flows. It's the financing activity. All right. Now, when I buy the shares back on, I'm the company. When I buy Bogamill shares back, because I don't want to offset, I don't want to uh dilute my shareholders.

20:27 So I'm going to offset my dilution. That repurchase is also a financing activity. So if an investor is going to look at cash from operations, he or she is going to see net income >> plus GAAP stockbased compensation, the 30 the 30 bucks uh over a three-year period. Going to get my cash from operations. Then I'm going to back out my capital expenditures. I'm going to get my free cash flow. But all of that cost that 90 bucks to you boil is not in there. It's all recorded as a financing activity.

21:03 >> So the argument I've made for years is well if I pay boamill in base salary or bonus, it impacts my cash from operations. But if I pay him in shares and buy back the stock, a true cash event, it's not an operating activity. That doesn't make any sense to me. That's that's basically it in a nutshell. And let me be very clear for anyone listening. I have no problem with the way Fazby or IASB does the accounting. I understand why they do it.

21:33 They're following the matching principle. I'm very glad that they're consistent in their approach. But it is the investor or the analysts whose job is to figure out what is the true economic earning power of the business. >> And that's why I suggest people make these adjustments. We'll see a real life example that you're going to walk us through in a few minutes, but I do want to ask you a handful of questions before we get there.

21:57 >> One thing when I'm I'm thinking of people receiving stockbased compensation. I have friends that work at at various companies that I mentioned to you, and there's this mindset of becoming an owner of a business, but the way it's set up, >> it might not actually work that way because you might be forced to to sell some of the shares or all the shares and and on and on. So the premise of employees becoming owners I think is good and and thoughtful and I think you know a wonderful idea to feel like an owner. But why it doesn't work in this setup people don't actually effectively feel like owners they have to part with some some of those shares maybe all of those shares if the taxes are due.

22:38 >> Yeah. And I and I think you hit the nail on the head. Part of it I think is because the taxes are due when the RSUs or PSUs vest. You got to pay it. And so if you don't have the money sitting there in your bank account, you're going to have to sell the stock. Now, I mean, I I couldn't imagine being um just just as an example, obviously not a recommendation of any kind, but let's say you were Microsoft a Microsoft worker in 1993, >> uh and you saw all the growth coming and everything else, and you're using a three-year vesting schedule. I'm making an assumption there, but it's probably about right. Um, so fine. By 1996, you have to sell the shares. Okay, fine. I would be annoyed because I wanted to hold stock.

23:19 >> Yes. >> Right. But I couldn't because we had tax liability, everything else, whatever. Um, so that to me is part of it. The other part of it is [sighs] the the there is a short-term nature in this and we all we both know that Buffett has argued when somebody gives you something for essentially free, it doesn't it's not costing the employee anything. you don't have the same tie to it as if you went out in the public market and bought the shares yourself.

23:45 And so a lot of the companies that I work with, their employees, we joke around about it, but they're like, "Man, I hope nothing happens before like March 3rd." And I and originally originally I would say, "Oh, why?" And now I know what the answer is. They're like, "Well, because that's when my shares vest." [laughter] >> Exactly. >> So then March 3rd comes around and it's like, "Well, should I sell?" Uh, so it's just to me it distorts it distorts the incentives a little bit. I think in theory these things are great. Um, and they I'm sure they work especially for venture capital backed firms, startup firms, things like that. But for more established firms, I I don't know that it has the same impact of helping people think and act like an owner.

24:26 I >> I'll ask you about that aspect when people receive the shares when they sell them and the timing of it in a second. But I'm thinking of Greg Ael. I mentioned to you, I was listening to an interview with him, the first one that he gave as the CEO of Berkshire now since Buffett retired. >> And one of the things that he said that stayed with me and I was thinking of this conversation is that he is buying shares in Bergkshire with his own money with the salary that he receives after tax. Like he emphasized it's after tax.

24:52 People forget, but the money that you actually get is after tax. That's the money you can spend on those shares. He says they don't have a practice of stockbased compensation within the company. I think he was giving us a lesson as he was giving that interview. But anyways, you know, think of that practice. If we do want to see employees and you talk to employees, executives, investors across the board, everybody participating in this phenomena. If you we do want them to be owners, how about we find a way for them to just buy shares on their own? The fact that you mentioned, you know, if you buy something on your own, you have a whole different relationship with it. A lot of the headaches we're talking about both from the company perspective and employee perspective are gone, right?

25:33 Because it's such a clear thing. You pay somebody a million with half of that they bought shares, they're on board and no tax event at the purchase. There's no vesting. They decided >> have is Bergkshire giving us a lesson that maybe we're missing. >> I I firmly believe so. And you know, this is a great question because I I was thinking about this this morning as well, uh, in a conversation I was having about this. Um, remember that Buffett talks a lot about, well, let me back up.

26:02 People talk a lot about intrinsic value, and they'll say, "Oh, Buffett talks about intrinsic value, blah, blah." And I say, "No, he doesn't. He doesn't talk about intrinsic value. He talks about intrinsic value per share." >> He's been very clear in his annual reports for years. He literally italicizes the per share [laughter] in that statement. And when you think about it just from an accounting perspective, how many things really impact per share value? There's not that many things, right? It's not like buying inventory impacts the per share value uh differently than it would the intrinsic value. It'd be a onetoone relationship.

26:37 But con, you know, like convertible bonds in the stock would do it. Stock-based compensation would do it. And I mean, I read hundreds of SEC filings a year, K's and Q's, and usually the only difference between basic uh earnings, basic shares outstanding and diluted shares outstanding is the impact from stockbased compensation. And so I I never talked to the man and I probably never will, but I firmly believe that what Buffett is talking about when he talks about per share uh intrinsic value changes is because of things mostly related to stockbased comp cuz as we as you started this podcast with most companies use this. It's not like most companies are out there doing convertible debt.

27:19 >> No. No. That's that's a good point. It became a practice. It's very common. We're trying to understand it. One of the points that you bring up and we'll talk more about it that you know accounting can be used for investing but it's an imperfect way to capture the economics and Buffett in his letters quite often would say accounting shows this the actual reality is that I'll ask you about it at the end kind of are we are we enjoying this shared delusion of what the earnings are or we should have some of a reality check I'll ask that at the end but I want to ask you about the certain other aspect of timing which I see among employees of companies that start joining companies and they might be joining a company at the peak. You know, we've had in even in the last five years, you know, two peaks, a couple of lows for a lot of stocks that we're talking about here, but many more as well.

28:10 >> If you join a company that you've been looking forward to working for, you know, this is exactly the company you want to work for, but they do hire you at the peak >> and everything is set up at the peak. your incentives and even your emotional psychological experience over the next two three years can be really horrendous when the stock goes down 50%. It might triple after that but it does go down 50% in the first 6 months.

28:34 >> Can you talk about how this messes with people's heads? You know it's meant to surf surf but it I think can mess with your head. And this is and this is the great Buffett quote, right, where he where he said, uh, if you want to be a if you want to be a stock picker, if you want to be an investor and you can't handle buying shares in a company and watching them drop 50% overnight.

28:51 >> Yeah. >> And and knowing you're correct and all that other stuff, then this then you have no business doing this. >> Yeah. >> And when you think about the small number of people that can actually handle that, uh, now we're going to do it with employees where most of them are not they're not stock pickers. They're not guys like us. >> So they don't have that mental fortitude already. So that's that's problem one in my mind. Um and so you know and I I I don't begrudge people of that. I mean you got to want to do this the way you and I want to do this. And so the psychological ramifications of this can be huge because obviously someone gets these shares and they think, "Oh, this is great." Especially if they have friends down the road uh who who went through this and made 10x their money and they get these shares and you know, like you said, now you're down 50% in value. It's crushing. And if this stuff is meant to increase productivity because of the the hope of a future big payout, then the reverse should also be true. When the stock goes down, it should crush productivity because, you know, you're kind of heartbroken.

29:53 >> Um, you know, I've I'm 44 years old. I've been investing since I was 18. I've trained myself that I don't really feel the pain anymore. Like if the stock goes down, it's like, okay, my analysis would was is either still correct, no big deal. I'll buy more or it's time to get out and you made a mistake. >> Um, but it it's taken years to get to get there, you know, and there were a lot of painful lessons on the way. So, I can't even imagine uh the negative impact of productivity that this has. And as a matter of fact, uh you're making a great point here because we saw this during the com bust.

30:28 We saw this within the last 5 years. If you remember a couple years ago, uh there was um uh what was it? Deep Seek out of China and everyone was like, "Oh my god, we could do AI for so much less." And you know, all the big all those big AI companies went down 30, 40, 50%. >> Well, what did they do? They granted that much more shares cuz they didn't want to make the payment in cash and they knew they needed to make up for that. So, we did this 25 years ago roughly uh with the com. and we issued a boatload more shares and we're doing the same thing and we did the same thing a couple of years ago in my opinion to your point to offset the pain.

31:08 >> Mhm. What happens in that scenario from a company perspective? From an employee it's a headache. It's it's a really you know messes with people's heads. But from a company perspective they issued those shares at a certain price and the price is you know one-third of what it was. what are the consequences when it comes to the cash flow statement and everything else? >> So, it really depends. This the beauty part about one of the reasons I love this topic is because it's complex. Um, but and what I mean by that it's complex because it's situational. If there is no share repurchase, it's less of a cash flow impact. So what happens is if there's no share repurchase when I give Bogan the shares and they vest um we're obviously diluting our shareholders. The only real cash payment the company makes at that time is when they withhold some of your shares and pay the taxes. You can't get out of that because the IRS says, "Hey, you you you made a payroll, so you got to withhold tax on that." Somebody's got to do it.

32:13 And it's usually the company that does it because remember this is going mostly to executives. So, you know, they're going to they're going to cover that. So, you'll see that you'll see that very clearly on the statement of cash flows, it shifts. It becomes more pronounced when there's a buyback because when there's a buyback, now I still have to make the tax payment and I got to offset the dilution. And where this gets really tricky in the situation that you're highlighting is if the shares went down 50%. and then later on they take off again. It's just a bigger gain that the company has to offset with its cash payment because the shares have run up.

32:50 >> Mhm. >> And so we're we're seeing that with some of the MAG 7 now where their stocks have gone up so much. They have to make bigger and bigger payments just because their stock prices have increased. So, it's like this weird world of where you want your employees to do well, but not too well [laughter] because if the stock goes up 10x and in three, four, five years, that's a big payment you're going to have to make.

33:15 >> I think it's a really hard task for a CEO navigating this and you know, you're helping people understand it. you're helping employees understand it and you're helping investors understand and it we'll come back to it and I'm curious to see the example if you can line it up but when it comes to the companies we're talking about they they're growing they seem to be at times overvalued. So those things that maybe wouldn't have mattered in another context they start to matter now because the cash flows we're looking at are not what we think the earnings and even the share count is not what we thought it is. [laughter] So that's that's something to think about. Let's pull up the example you have in mind and let's go over some numbers. Let's do it in a way that people that are just listening and maybe we'll look at the video when they get back home, they can participate as well.

34:04 >> Yeah, there we go. >> Perfect. So the re real quick, the reason I say why should we care on this is because well uh generally accepted accounting principles aren't accounting for the total cost of this. Remember if I give you an RSU and expense it at 30 because that that was the market price at the grant date but you end up selling out at 90 that $60 difference is never on the P&L. >> Okay, fine. So that's part of the problem. It's, as we talked about before, free cash flow doesn't capture it either because all of this shows up as a financing activity, not an operating activity. But to me, if it's compensation, that's part of our operations. That's part of SGNA. That's not a financing activity, so to speak.

34:42 At least that's the way I argue looking at it. And again, not saying that the accounting rules are wrong. I just think the investor needs to make the adjustment just like they should make a LIFOto FIFO inventory adjustment or uh operating leases to a finance lease adjustment. you know, all the things that you would teach someone in a financial statement analysis course. So, the other problem is um because of this, because we're looking at well, because we're ignoring the $60 gain that we're going to offset with a repurchase, our operating income is overstated, which means return on invested capital, return on equity, return on assets looks overstated. That means that our credit risk looks lower than it really is because our if you want to use IBIT for that like a credit rating agency analyst would our EBIDA is overstated and on down the list and so there's a problem here. So even without the repurchases the cash costs of stockbased comp can significantly reduce cash flow because of the tax payment that we talked about earlier. But when we get into the example, so here's one company. Uh this is their statement of cash flows. And I'm going to focus on this 102 uh billion in cash from operations for uh January 25th, 2026.

35:57 Well, they're only they only have 6 billion in um capital expenditures. So it looks like this company is just raking in money, right? 96 billion dollars a year in free cash flow. That's great. But then you come down here and you come to the bottom and you see 7 billion 7.9 billion for taxes or tax payments. Sorry, payments for uh taxes withholding taxes. Well, that's exactly what I'm talking about. They withheld shares and paid that amount. Now, this is the wild part, Bogamill, because it's 7.9 billion. Go up top really quick to this 6.4 billion up here, 6.386, right?

36:39 That's the amount that they expensed for the year under GAAP. >> So for the RSUs that they've uh issued over the last three years, a third of each combined gets to 6.4 billion. The cash payment that they're making for tax withholdings for RSUs that they issued in several years ago is greater than the amount that we're actually recording on the P&L just for the tax amount. >> Right. I mean that that just like that stood out to me. I looked at it and was like, "Holy cow, the taxes you're paying are greater than the gap cost." And remember, the gap cost is never going to change. It's that and >> let's pause here because this is fascinating, right? So, we're looking at a company, we don't see the name. I think that's better for for the audience, but an example.

37:26 >> You have a company that has 120 that's billion, right, in net income. >> You have 10 and change 102 billion in operating cash flow. And the two numbers that you're pointing out, so we're talking about 100 plus numbers, right? And then six billion and change in stockbased compensation. But then you point out if you actually scroll down to the bottom of the page, the payments related to the taxes related to the stockbased compensation are 8 billion in that year. It does make you pause. Wait a second. You guys are paying in the last 3 years, it's 3 and a half, 4.7, 6.4 4 billion in stockbased compensation, but your expenses related to the taxes went from 2.7 to 6.9 to 8 billion. What's happening? I think that's the question you're asking.

38:12 >> And and remember that's just the tax portion. So let's just say I gave you a 100 gave you 100 RSUs. I withheld 30 for taxes. That's the 7.948. But the other 70 shares that you're selling that I'm repurchasing >> shows up in this $40 billion buyback. >> Got it. >> Now, there are some there are some very well-known investors who look at this and say, "Well, it's the entire 40 billion plus the 7.9." No, what you have to do is figure out how many shares were repurchased to offset dilution, and then the remainder was just to reduce the share count, so to speak. Mhm.

38:49 >> Um, so there's some people that are out there overstating this and it is what it is. But directionally they're correct. >> Mhm. >> So, you know, this isn't like just Kevin's view of the world. There's a couple of there's a couple of other guys doing this. There's just not many. [laughter] >> So, so to to do it the right way, right, we're working with, you know, three numbers here that the company discloses. The stockbased compensation in the year, which is >> just what they issued and that will vest over a couple of years, right? Or this will couple of years, right? And then >> yeah, usually like usually three four years. Yeah.

39:20 >> So this is kind of a forwardlooking number. It tells us a bit about the future. It's a open-ended as we'll see in a minute, but forward commitment. >> Yeah. >> Now the taxes, they're due for what's been issued before. And >> yeah, >> right. And we can't tell unless there are more footnotes if this the 8 billion. Is it for last year, last two years, last three years, last four years? We we don't know. Do we know?

39:50 >> No, we don't we don't really know because most people when they get their RSUs and they vest, they're going to sell them. So, it's probably within the last three or four years, but some people will hold on to those RSUs. They'll pay the tax and hold them. >> Uh and so the these things could be 10 years old. It's unlikely, but it's possible. So I I can't say definitively that it's like, oh yeah, that 7.9 billion was related to these shares issued in that year. I can't get it that close.

40:18 >> Before I ask the next question, the RSUs, some of them people actually hold them, right? They they don't sell all of them. They sell as much as they have to to pay the taxes. But sure, >> I I would assume that some people if they want to stay at the company longer term, I don't know if it's happening as often as it used to in the past, but if they do even 5 years, they're holding on to some of those shares in in hoping that this will be more than it is today.

40:44 Yeah. Okay. And then the repurchases, this is just that year shares repurchase, but at at least we have a couple of follow-up questions to the company and you know, probably want to read more of the filing if it's available. But as you said, are these just offsetting the dilution or are you guys actually shrinking your shirt count? You know, two different things, right? >> That that's worth exploring. Yeah. And I have I have another example where I can walk it through all of it because it's there's a couple of companies where the disclosures are really good. So it makes it really easy to figure it out.

41:19 >> Are they required to disclose a lot more or is it a choice? How does it work? >> Now for so you have to obviously you have to disclose what you're seeing and then in the footnotes they're going to tell you how many RSUs were vested that year. They'll tell you how many stock options were exercised, issued, cancelled. Um, so if you know how to read the footnotes and tie it to the financial statements, you can you can do the math. I mean, it's the fun part about doing this is I've done this with CFOs and whatnot and they all say the same thing. I can't unsee this. Just like once you see how to do it, it's like, oh, that that's it. It's like, yeah, pretty much.

41:57 >> Do you have a page for that? >> Yeah, let's uh Yeah, let's let's dive into another example here. So, uh, another company that we won't say the name obviously, but where a lot of the meat lies is on the statement of shareholders equity, which is easily the statement that people pay the least attention amount of attention to. So, you'll see it over the couple of years, right? They start at the top with 2.614 uh billion shares. Yeah, billion shares.

42:22 Uh, there's some issuances, there's some deductions, and you see what the share count is at the end of the year. So, let's focus on 2025. Um what happened here is this company issued 63 million shares. Okay. Uh you'll see in a minute that's pretty much all stockbased compensation. >> Mhm. >> Then what they did was they had to withhold 27 million. When those RSUs vested, they withheld 27 million and they paid the tax on this. So the 27 million shares resulted in a cash outflow of $18.4 billion. We'll see that in a minute on the statement of cash flows. Then what you have to ask yourself is okay they actually repurchased 40 billion or million shares for 26.3 billion dollars.

43:08 >> Well 63 million issued 27 million canled or withheld I should say for taxes. Well 63 minus 27 is 36. So 36 million shares of the 40 million buyback were simply just to offset dilution from stockbased compensation. So fortunately 36 over 40 is 90%. So 90% of that 26.3 billion is the real cash cost to offset dilution.

43:38 >> Mhm. >> Plus the 18.4 billion in taxes withheld. You got to add those together. >> It creates a this, you know, three-dimensional picture of what's happening in a particular year, what's happening over multiple years. And this is part of the filings that I think very few people look at. I actually look at it. I'm very curious what's happening and >> how this is moving around. But >> fascinating to look at and it adds another layer of complexity to the numbers we looked at. Just for the benefit of the audience that's not watching it with us, this company has 2 and a half billion shares, right? And we're talking about 63 million issued.

44:22 >> Um 27 withheld, 40 million repurchased. But just to give you an idea, you know, it's still just a few percent you would think of the share count, but it adds up over time and makes a difference. >> Well, and and so let's go to the next one and see how it adds up because the shares to your point, it doesn't look like big magnitude on shares, >> but let's see what it looks like on cash flow.

44:46 >> So, when we go to the statement of cash flows, this is a company that generated uh about 116 billion in cash from ops, >> right? They spent 70 billion on capital expenditure. So this company is very big in the AI spending and as you can see the capex has been growing considerably. >> Yeah. >> Um so is the cash from ops but the cash the the capital expenditures growth is faster than cash from ops. Okay. There's the 18.4 for the tax withholding. It's a onetoone match.

45:17 >> And then 26 uh.2 billion right here for the share repurchase. Well, like I said, 90% of that was to offset dilution. So, what I'm going to do is I'm going to take 18.4 plus 90% of that 26 and I'm going to get that's going to be about, let's just say, $42 billion. I'm going to take that 42 and deduct it from 1158 because, as I said before, I don't care if I'm paying bogeamill and base salary, bonus, or stock. It's compensation. It's an operating activity, >> right? And that is going to take this company's free cash flow down from 46 billion to about four billion.

45:57 >> And as you know, Bogamill, because we were we've we've seen presentations on this and uh text messages and things like that, people will say, "Well, I don't think that's right." Blah, blah, blah. Uh and they they go off on these wild tangents. And all I say is, to me, it's very simple. If you were going to buy all of this company, let's just say you said the free cash flow was $46 billion and you think it deserves a 20 times multiple. You're going to pay $920 billion.

46:25 Fine. You're going to be very upset when you find out that you are only making $4 billion a year in cash profit because you took the company off the stock exchange, but those software engineers or whoever they are are going to say, "Well, I still expect to get paid, guys. Otherwise, I'm just going to go to your public competitor. >> So, you're going to have to pay him in cash at that point. >> So, to me, it's end of discussion at that point. You're either getting the 46 billion that you use to value the company or you're not. And if you're not, that's it.

46:58 >> So, this is such a helpful example because let's imagine that this company was private, privately held, familyowned. There are many businesses that are really large, family-owned. They don't issue shares. >> Sure. >> They don't have a public market for their shares. They don't even probably know what the the price should be for their business like a lot of private owners. They don't. But the expenses that you described unless it's restructured in some way would have been the same. Right. So if this company believes that they have to compensate their employees this much in the tens of billions that you just quoted for one single year. If this was a private company, assuming they need the same talent, the same capacity, the same staff, they need the same 40 billion or whatever it was to spend. So I think that's a reality check of seeing if this was a private company, that's the cost to run it. Like that's the cost to actually run it.

47:52 >> Yeah. Otherwise, otherwise these employees are going to go somewhere else while they'll get the shares. So you either pay them in cash or they leave. >> Well, I think this this begs for a question here. Do you think those employees by accident get overpaid? >> I mean, [sighs] it's hard to say, right? Because I'm I mean, I'm a capitalist and so I I believe that obviously the market will pay whatever whatever it'll bear. Um, are they getting overpaid? I don't know.

48:21 Um, I wouldn't want to make that claim because then someone could say, "Well, Kev, you're overpaid." And it's, "Okay, fine." >> No, let let me let me rephrase it. So, okay. You you offer me a job, a role at your company, right? and you say you know this is this much whatever 100,000 and I say no I I would take this job for 150 >> and right and instead of it's very clear for me like in my mind that's what my work is worth and then we agree on 140 between the two of us and I'll take the job >> now I know what my paycheck is I'm comfortable with it I'll accept it Kevin is paying me now if you say hold on a second I'll pay you 30,000 in cash and the rest in RSUs they will invest over four or five years and I have no idea what the price will be. Hopefully, you know, we're growing, we're expanding, you're adding all those clients, all those business opportunities. I'm guessing that Kevin's business will go up 5x. So, I will make at least 5x with him.

49:15 >> I'll say, "Okay, well, I'll live on the 30,000, but the other 110. It's it's optional. It's probably a lot more, right?" So I'm accepting a certain risk >> and then >> you take on this risk really because >> your company grows 20 times, right? >> And you owe me, you know, a couple of million >> and then I would have worked really hard for the 140 because I think that's what my >> role is worth at your company right now.

49:42 but you get you pay me two and a half million and I'm going to say thank you and I appreciate it but it's it's kind of out of whack because I didn't expect to be paid this much right like when you say market it's like it kind of distorts the market because >> an employee is accepting a risk as much as the the company is different kind of risk where >> I don't know how much Kevin will end up paying me because if your business doesn't do well >> and you know at least the market perceives it. I have to highlight that the market perceives that Kevin's business is not doing well for whatever reason and your stock price is down.

50:20 >> I don't get my 140. You know, maybe I'll get 70 total and then I feel, you know, short changed because I did provide the work that I think is worth 140. Right. So, I'm trying to capture this phenomenon where the employee, as you mentioned before, is playing the investor game that he or she did not necessarily fully understand or even sign up for. >> Right. No, in that regard. Yep. Completely. Sorry, I misinterpreted where you were going. Yeah. No, I completely agree with what you just said. And the the other thing that worries me about this Bogamill, because the company we're looking at is a is a big AI company. Um what these companies are now doing is remember these were asset-like businesses. Now they're very asset heavy.

51:06 >> They're very asset heavy. Look at their capex. And this is going to continue uh because it it has to. I mean, you know, that's just how a the AI world is. It's it's uh very capital intensive. And now they're leveraging their balance sheets. And you can see it right on the statement of cash flows. Here's 30 billion that this company borrowed last year. They borrowed 10 last year, eight and a half the year before. And some people and they will, this company will tell you, oh well, this is to grow our AI ambitions. And I'm sitting there thinking, I understand why you make that argument. I could just make the same argument that you're borrowing that money to pay your employees because if you weren't doing this stockbased comp, you wouldn't necessarily have to [laughter] to borrow the money for you. So, it's just >> so it's a risk because now they're levering up their balance sheets. And so everybody's saying, "Yeah, but look at the look at the return on invested capital." Well, if your numerator and return on invested capital is 1158, hopefully by now I've proven to you that it should be lower than that.

52:05 >> Um, and that's where this gets really tricky. And so it's just, you know, then then people will say, "Well, this isn't like the com because these companies have revenue and cash flows." True, but they have revenue and cash flows from their legacy businesses. We still don't know that they're generating any cash flow from their AI investments. The market will only put up with that for so long. And at some point, if they don't start generating a real return on this, the game's over. Or if they do start generating a real return on this, but they keep giving all the value to the employees, the shareholders might get ticked off.

52:45 >> You're touching on a couple of things here. one is the econom the economic reality the actual cost of doing business >> might be higher than what meets the eye at first I think that's the big big exclamation mark here >> and second thing that it belongs in a whole different episode >> but the usual cycle of a business and professor the madoran wrote a wonderful book about the life cycle of a business it goes through the natural stages that you would imagine of you know any kind of living entity you know it's born it grows It grows really fast. It maximizes its profit potential. The best margins, best returns. Then it kind of starts to slow down. The margins kind of drop or or not go up anymore. The returns for the new available opportunities are not the same anymore. The business starts to return cash. It starts paying dividends.

53:35 These days also does buybacks. And then it's a managed decline. And that stage is kind of tricky for value investors because those companies borrow money, make aggressive acquisitions, promise big synergies and on and on separate. I think what we're seeing with the companies you mentioned where we're focused today, but not only because a lot of companies use stockbased compensation too, >> not outside of tech, I feel like, but those companies are going through a second or third stage of youth or growth. And it's a very different stage than the one we're familiar with which was as you mentioned >> asset light. Some of them had a handful of employees at the beginning. Now they have a lot of employees very well paid employees and the new opportunities demand a lot more capital and you have couple of things happening at the same time. expensive extensive staff people working plus very high demand on new capital and paying attention to the things that you mentioned they kind of they they all meet in one place and you realize the numbers I'm looking at are maybe not accurate to where these companies are and definitely where these companies could be in the coming years that's what I'm hearing exactly right and one other thing just for the for the people who would still disagree and say well I think This is more of a philosophical argument. Well, let's put it this way.

55:00 Um, under under GAP accounting, I'm going to expense, back to our example, I'm going to expense the $30 on my P&L, and I'll get a tax deduction for that of some of some amount. Let's just say let's just say we're in a 20% tax bracket. Uh, so 30 bucks, 20 time 20%, right? A $6 tax deduction. However, that's not what the IRS does. The IRS doesn't care about that. The IRS essentially uses cashbased accounting. So the IRS is going to say, "Well, no, Bogamill sold the shares at 90. So company Bogamill's employer, you get a $90 deduction, not 30. So you get $90 times 20% or $18. So $18 is your tax deduction under what's known as the quote intrinsic value method." End quote. The gap was a $6 deduction. So what happens to the $12 difference?

55:52 Well, this is what's known as the excess tax benefit from stockbased compensation exercise. >> And what you what used to happen, Bogamill, is that $12 would be sitting right down there as a cash inflow uh right above taxes paid related to net share settlement of equity awards. It was a financing activity. Then around 2016 or 2017, the Fazby changed that and that tax that excess tax benefit is now an operating activity. So for all the people who say, "Well, this isn't an operating activity," then explain to me why the IRS says that it is >> and why Fazby says that it is. The rest of the transaction is not, but the excess tax benefit is. And so in some regards, I feel to your the point you just made, I'm I'm twisting it a little bit, so I'm not trying to put words in your mouth, but I think some people are trying to have their cake and eat it too.

56:46 >> Yeah. And you you have to figure out for yourself as the analyst which way do you want to go about this. I have my opinion. That's why I'm on this show. Thank you very much. [laughter] >> I think I'm right, but that's where uh reasonable people can agree to disagree. Obviously, >> I'm grateful you're sharing it. What I see is just a time delay between the realities in many ways, right? That explains it that you you agree to a certain expense when it comes to your employees today. You're not so sure how you're going to pay for it in the future. Once that future comes, you're trying to figure it out how it lends and how you fund it. And in the reality where you have to increase your capex with the changing business model, you might not have the extra cash. So, you're borrowing. So, it's all connected. I don't want to miss this, but just as a reminder, the $30 in the example that you had, tell us why it never shows up anywhere. Just just as a reminder.

57:43 >> Remember the 30 does the 30 is what shows up on your P&L. So in in the example we were using, the $30 is this 20.4 billion in stockbased comp. The 30 is what we record under GAAP. >> Okay? >> The 90 that you sold the stock for, you get that after we withhold taxes. What I'm saying is $90 that you actually sold it for minus the $30 gap cost. There's that that 60 bucks difference. It's the 60 that never shows up on your P&L, >> which is the actual cost that we cover through the per purchases if we choose to, right? Like that's where you're going with it. Unless >> plus the 30. Yeah. So the 30 we're also covering. So we got that >> uh in a different time period obviously.

58:28 >> We got the 30. It's the 60 that's just it's never there, but it does show up here at at the bottom in that 184 and that 26.248. >> The tax is paid and then the company doesn't have to repurchase those shares. But if they choose to then that reality kind of it's like a a photograph like you know is there a ghost the ghost makes an appearance and the ghost is there on the state pair of cash flows.

58:56 Well, and to ju and to just wrap up this example because I'm I'm still a teacher at the end of the day. So, for instructional purposes, people say, "Kev, where can I find the 63 million shares from that statement of shareholders equity?" Well, in the footnote and the sharebased compensation footnote, this particular company only does RSUs. You see it right here. Every time they give the same disc, every company gives the same disclosure. They'll tell you how much they started with, how much was granted, vested, forfeited, or canceled. The vested is the amount that um obviously vested it's a taxable event that was 62 million shares. The 1 million difference because it was 63 in the table. This company also does uh employee stock purchase plans like you know you buy the shares at a 15% discount. So that's in there as well. So that that's the delta. Um but most of the time you can just tie this out >> because the numbers are staring you in the face in the footnote. And as a matter of fact, because I'm geeking out on this, uh, in the next column, this 31768, notice it says weighted average grant date fair value.

60:03 >> So, we're going to take 61906 times 31768. That's your gap cost spread out over for this company, uh, I believe it's three a three-year vesting period, which they'll tell you what the vesting period is somewhere in the footnote, so you'll always know how how long it took. You know, this is such a great reminder of this revelation realization that we have sometimes that the income statement, the balance sheet, the cash flow statement, it shows us the past. But here it's a fascinating phenomenon >> because it's a glimpse to the future.

60:35 >> Right. >> Right. >> I think what you're showing showing us is these shares will show up somewhere in some way in the future and the taxes related to it and if they're repurchases, repurchases relate to it. So, the stockbased compensation footnote, as sexy as that sounds, but that can show you, [laughter] >> that can show you what this company committed to. >> Well, and and I I don't have it on here because I couldn't screenshot the whole thing, but right below this little paragraph, every company always has a a one sentence where they say the unrecognized value uh of like soontobe vested stockbased comp is X. Uh, and so some and sometimes you'll see like, oh, the unrecognized value of stockbased comp is like $40 billion. That's what they have yet to put on their P&L. Um, so they're telling you like, look, based on current prices, we know what's coming. And so it's just, it's like, wow. Okay. Um, you know, take that as a percentage of revenue or operating income, whatever you want.

61:34 It's like, these are real numbers that I cannot believe people want to ignore. Mhm. And that's based on the current price when this document was produced. Yeah. [laughter] >> Which >> that's based on the point of course, >> right? And if every Well, it's kind of interesting because if everything goes well, if there's a way to put it that way, then you would like this company to do well, you would like the fundamentals to improve. You would like the price to go up.

62:01 >> But it's it's bittersweet here because the cost that you will be facing will be so much higher, right? It's it's >> you're playing a fascinating game. I think running a business of any kind is hard. Running a massive business, it's an impossible task. People look at CEOs, but >> you know, 100 countries, 30 product lines, logistics, ongoing conflicts, tariffs, politics to navigate a business. And on top of it, you have this phenomenon that doesn't allow you as a CEO and you as an employee to figure out exactly how much did I get paid, how much this will cost. Y >> I want to ask you one last question maybe too.

62:41 >> When I think of the market as a phenomenon, you know, it's a place where we go and we we change ownership in shares of companies that we analyze and know, right? The the voting machine, weighing machine, as Graham told us. And you know, if we buy into this idea that the market processes all the information that's available and however you believe, you know, efficient or not efficient, I think it's very liquid doesn't make it efficient, but that's just my belief.

63:02 >> Ah, I like that. I'm still on that one. [laughter] It's very liquid, very liquid in a lot of companies, especially if you're you're not moving hundreds of billions like Buffett is. It's, you know, you can really buy and sell whatever you want most of the time. But anyways, if we're going in with analytical tools that are imperfect to analyze data that's available, right, to make a guess about the future that's unknowable in this, like it magnifies the problem because I have some doubts that this market is valuing weighing those companies correctly. If you and I have to spend an hour to just scratch the surface of the phenomenon that very few people even pay attention to.

63:44 >> Yep. Could not could not agree more. I've been thinking that for years. How is this efficient when they're not paying attention? And the risk with these when I think of the MAG 7 if they're 3540% of the S&P 500 and pretty much they're all not every one of them, but they're kind of all doing this. It's a >> uh it's a problem. [laughter] [gasps] >> So, one last question kind of maybe an observation. If we and it it's as philosophical as it is, you know, investing or accounting related, but if we all share the same delusion, you know, it's it's the the emperor wearing no clothes, right?

64:23 >> Mhm. >> We need the little kid in the crowd to say, "Hold on a second." [laughter] >> Right. Is this what we're doing today? >> I I believe so. Yes. And you know, when I still taught undergraduates, I don't teach them anymore, but when I still taught undergraduates, I I would literally ask them in my in some of my courses, >> give me examples of when humanity just kind of lost its mind. >> And you know, you hear you hear some of the most wild atrocities that have ever have ever plagued mankind. Uh, which we don't need to give examples. Everyone can come up with their own. When you see things like that and you say, "So, yeah, if we can go to that extreme, I'm pretty sure we can ignore for a little while the cost of stockbased comp and think everything's okay because human beings are great at at ignoring >> things that they shouldn't ignore."

65:14 [laughter] And the comments that I the comments that I've heard lately are this is philosophical. Um, you know, the employee is bearing all the all the costs, blah blah blah. And I'm sitting there thinking it's literally on the statement of cash flows. It is a cash outflow. I don't know how else to make this any clearer. And people will say, well, but it's, you know, that's an estimate. And I'm like, no, it's the gap cost that's an estimate. Because as you rightly talked about before, we don't know what the person is going to exercise or uh the stock at at some point.

65:49 >> Yeah. >> But when they do, we can see it. I just showed it to you. I know what the cash cost is >> because I I can multiply Um, so yeah, no, it's a taking the scenic route to answering your question. I apologize. Um, but I'm I'm the point that I'm making is I agree with you completely. I just think there's kind of a mass delusion going on right now. And this is not the first time that we've seen it in in mankind and certainly not in investing. I mean, look at what they did with back in the 1600s. [laughter] >> We we're doing some of those things all over again. You know, one question dawned on me as I'm listening to you and and digesting everything you said. Let's assume just for a second, the last few minutes of our conversation here that somebody held on to those shares. You know, you talked about Microsoft 1983. I don't know where the price was, but I imagine it's many, many times over of what it is today.

66:40 >> That share that share was added to the share count at what point when it vested, right? It was already added to the share count. Uh well yeah because when you you got to convert from basic to diluted shares and and you'll see the difference between the two. It'll say like the impact of future dilution basically. >> Um so it's really for the most part it's really at the grant date because then they're going to say hey we expect these to vest.

67:06 >> Okay. >> Um but so you'll see them in some regards and so you know the company that we just looked at as you rightly pointed out it's two and a 2.5 uh million shares whatever it is billion shares. Um, and so it looks like a couple of million shares is no big deal, but that's why you need to convert on the stock price because then you realize, oh, the number of units might not look that big, but the cost of it really is.

67:30 >> Mhm. Especially if the stock price keeps going higher. Fascinating phenomenon. I think it when you talk about the proportions today that the numbers have become so big that we just have to pay attention. maybe ignoring it years ago when it was a marginal tool used by very few companies, you would have said, "Oh, you know, it's it's not that important." But now, especially for some of the cases you bring up, it's so big that it it eats up all the cash flow that you thought you have. And I think that should make us pause.

68:00 >> Well, and and one of the things I love about your podcast, Bogamill, is because you always go into more of the psychological side. So, if I could just end on a psychological statement. Uh I presented this at a conference recently where somebody stood up and said look you you are technically correct. I don't disagree but if I paid attention to this related to this one company I would have missed the runup of eight times in five years on this one company.

68:24 >> I do not disagree with that at all. But as Howard Marx right someone that we all admire would say just because you're right be careful with how you're right. like, you know, you got the outcome that you wanted, but it wasn't because what you thought was going to happen happened. You know, like I could I could delude myself into thinking that I belong in the major leagues as a baseball player and when I get in the batters box, I close my eyes, swing as hard as I can, and hit a home run. That doesn't make me a baseball player. [laughter] >> And to me, that's the that's the risk that everybody's taking is that if you're not going to do this right, if you're not going to think about this properly, more power to you if you get lucky. I have no envy whatsoever for uh you know to towards those people. But I I'm like to consider myself a professional that knows what he's doing and that to me is more important than being lucky.

69:15 >> So >> take it for what it's worth. >> Analyze it, be informed, then make a decision if you want to be a part of that company. I think there are some incredible businesses out there, but it's worthwhile to go for the numbers to see what the numbers really are. Kevin, you were featured in Wall Street Journal. You pointed out the issues we've been talking about today. tell us what happened since and how it's already making a difference.

69:37 >> Yeah, it's it's been really fun. Thanks for asking the question. So, um this topic has bothered me for years. Uh and then eventually I got smart and I said, "Wait a minute. I always read the Wall Street Journal. I love John Wild's columns because John Wild was an analyst uh under Jim Chainos uh and whatnot." And so I I didn't know who he was. I never met him, but I've always read his stuff. He runs the he does the Herd on the street column. So I reached out to him and said, 'Hey, I got this idea. I think you might be interested. Long story short, he calls me like the next day. We spend the next couple of days talking about it, this and that, and I have no idea if they're going to run a story because the Wall Street Journal is really good with their integrity as like we will not tell you we're doing a story. We'll talk to you, we'll learn, and we'll send it to you after we publish it. Great. So, I'm with a client with a consulting client. I have to give a keynote later that day which was awesome. Um because I wake up seven in the morning and I get an email from him.

70:37 They ran the story and the story was on uh he decided to use Meta. I had no say over it. I just showed him how things work and then he gave me he did some quotes this and that. Okay, that runs on Monday. uh Wednesday afternoon after close, Nvidia releases their earnings and I'm flipping through it and at the bottom of their uh adjusted earnings table, they say starting Q1 2027, which is right now, um we are going to change our disclosure policy and we're going to start including stockbased compensation in our adjusted earnings numbers. Now, I don't think they're going to go far enough. They're going to include the gap cost, the $30 in our $90 example, but it's better than nothing. It's a start.

71:22 And so I'm kind of curious to see what else comes out of this. And so then John wrote another article. He posted on LinkedIn about it talking about Nvidia. Um, and then I'm working with a couple of other publications right now because they they've tried to piggyback this, but they're getting it wrong. And they're they're big publications. They're Wall Street Journal like so. So this is definitely gaining momentum. Uh, and as John Wild, who I now consider a friend because he's just a really good reporter and he's a good analyst, um, he said, he goes, you know, my goal with my articles is to change the discussion, you know, to to change the way people think. And I I think we've done that and that's why I really appreciate just being on your podcast and being able to talk about this because I I think it's an important issue. I think it's something that people who are serious about fundamental analysis and value investing should should know about. So, uh, it's been truly a pleasure doing this despite some of the vitriol.

72:14 [laughter] >> As I told you, you're just opening our eyes to something we haven't seen before. Some of us are more ready to see it. Some of us need a minute, but it cannot be unseen once you saw it. >> That is the quote I hear of. I hear that from I've heard that from Fortune50 CEOs. They're like, I can't unsee this. And I'm like, yep. [laughter] That's just, you know, you can lie to yourself if you want to. So I just don't like doing that. So >> Kevin, this was such an amazing conversation. I'm so glad we did that tough topic, but we did it in a such a way that I think a lot of people will en enjoy it and at least pause and think and when they invest again or talk to their adviser, they will say, you know, these few companies have a lot of stockbased comp. How does it really work? So ask those questions after listening to this. And >> Kevin, thank you so much. This was incredible.

73:05 >> No, truly my pleasure. Bogamal, thanks for having me on again. >> Before we wrap up, a quick reminder. If you want to supercharge your investment research like I have, check out Tenzing Memo. Don't forget to use code billions at sign up for your extended trial and 10% discount. It's been a gamecher for my process and I think you'll find the same. Thanks for listening to Talking Billions and I'll see you next time. You were listening to Talking Billions.

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