Issue 97, 22 February 2002
Investor's College Valuation implications The valuation implications of options are real but many companies either aren't aware of them or choose to turn a blind eye.
To illustrate our point, let's take two identical companies, both with 100 shares on issue. We'll assume company A has no company issued options and company B has 10, issued at the current market price.
Anyone buying a share in company A receives 100% of both the upside and downside in the share price over time. But those buying into company B are taking on 100% of the downside risk yet accepting only 90% of the upside.
This being so, company B's shares should trade at a lower price than A's. But because it's an opportunity cost, it doesn't show in the company's reported profits, although it will eventually reveal itself in the earnings per share figure.
At one AGM we suggested that the company provide executives with loans to buy shares rather than issue options. We were almost laughed out of the room but our logic is more than defensible.
First, executives would truly be in the same boat as shareholders. Second, if the shares were purchased on-market, there would be no dilution of current shareholders' interests.
Perpetual Trustees has a policy of purchasing on-market the shares it provides to staff. It's the type of behaviour we like to see. Unfortunately, it's also the exception rather than the rule.
C o p y r i g h t Š 2 0 0 6 The Intelligent Investor . Published by The Intelligent Investor Publishing Pty Ltd. ABN 12 108 915 233. Australian Financial Services Number 282288. PO Box 1158, Bondi Junction NSW 1355. Ph: 1800 620 414 Fax: (02) 9387 8674 WARNING This publication is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, seeking advice from a financial adviser or stockbroker if necessary. Not all investments are appropriate for all subscribers.
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