Operating cash flow sounds great, right? Visions of greenbacks wending their way down the river for you to grab, like a bear fishing a salmon-filled stream. When all is said and done (and when is that, I ask?), OCF is the green available for management to use for good or for ill.
But is it real money? Not when the cash flow statement adds back alleged noncash charges that are really claims on future cash. What really burns my toast is adding back stock-based compensation. What, are stock options mere confetti to use at an investing party? Cakes and ale all around? Maybe for the recipients.
Stock-based comp is an IOU issued by the company to employees, and you, as an investor in the company, hold that IOU. It's your ownership that's going to be diluted when the stock-based comp -- the options -- are exercised. You will own less of the pie without selling a share. Diluted ownership is cash out of your pocket.
Of course it's cash, but it be pickpocketed today, tomorrow, or down the road! If employees didn't consider it an IOU, they wouldn't accept it as compensation. It's potential dilution, and it's not really available to run the business. The best practice would be to not add back stock-based comp to cash on the cash flow statement. Most of the time, all it does is give Popeye's Wimpy what he asked for: a hamburger today for which the company will gladly pay you on Tuesday.
A matter of scale
A little stock-based comp is not a big deal, of course. But when the IOUs are 50% or more of OCF, say, there's a real problem. What about 100% or more? The company produces no operating cash flow other than adding back its stock-based compensation. That's one big honking IOU.
We're going to count down the 10 worst offenders on the list over three days, going backward from No. 10 (bad) to No. 1 (the worst). Here are the first four:
Cash Flow Statement (all TTM, $ in millions) |
No. 10: Zynga |
No. 9: Alkermes |
No. 8: Exelis |
No. 7: Cepheid |
---|---|---|---|---|
Stock Based Comp | $782 | $31 | $23 | $22 |
OCF | $357 | $11 | $8 | $7 |
Stock Based Comp as % of OCF | 119% | 183% | 189% | 235% |
Real OCF | ($425) | ($20) | ($15) | ($15) |
Earnings per Diluted Share | ($0.99) | ($0.63) | $1.72 | ($0.07) |
Source: S&P Capital IQ, data as of market close, Sept. 24, 2012. TTM = trailing 12 months.
No. 10: Zynga
The catch is that when those IOUs walk out the door, the company will have to issue those or larger IOUs to new hires walking in. At No. 10 on the list, with TTM stock-based comp at 119% of OCF, Zynga lives in Funny FarmVille, where it doesn't pay investor-players with cash.
No. 9: Alkermes
No. 8: Exelis
No. 7: Cepheid
Investors in these companies think their ownership floats on a river of greenbacks, but they are merely IOUs. Someone will collect, and while it may not be the Mob, your pockets will most definitely get picked.
Steer clear of these four, which are far below the deep waters where you'll find contrarian investors. Facebook may deign to improve Zynga's prospects. Alkermes may hit the drug approval lottery. Exelis may produce green from military camouflage and Cepheid from protection from biothreats. But there are better investments -- heck, there are even better speculations!
I'd recommend selling or avoiding these four stocks on the cash offender countdown. Join me tomorrow when the countdown continues with offenders No. 6, 5, and 4.