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He goes onto explain that they use discounted future free cash flow projections to evaluate companies - not current earning and P/E ratios so the same arguments hold - some companies add back SBC to these figures (as does Intuit and DT) - others don’t like Microsoft. If you use Intuit or DT’s adjusted figures to calculate intrinsic value you will overvalue the companies - substantially and the more so the higher the level of SBC. It’s crazy and analysts are not immune to being duped..

Anyway, if you are counting on a takeover to drive the SP higher, good luck to you.

I still hold with a long term view of DT as an independent company, but the jury is still out on whether it will prosper independently as there are troubling signs that have been alluded to on this bb and elsewhere,

Bobacaca - an extract from the annual letter of Fundsmith demonstration how SBC causes complication in analysing companies. I hate it.

‘Take the example of Microsoft and Intuit. Microsoft shares are currently being valued at a P/E ratio of 25.0 times the consensus EPS estimate for the fiscal year ending June 2023. Meanwhile, Intuit is being valued at 28.4 times the non-GAAP consensus estimate for the fiscal year ending July 2023. Many investors and analysts may accept that Intuit is trading at a higher multiple given expectations of greater growth potential. However, Intuit removes share-based compensation from their non-GAAP EPS whereas Microsoft does not. Given that Intuit’s GAAP EPS guidance for the year ending 31st July 2023 is $6.92–$7.22, its non-GAAP guidance is $13.59–$13.89, and the consensus estimate for 2023 EPS is at $13.69, it seems clear that most sell-side analysts are accepting the company’s non-GAAP adjustments, which includes the removal of some $1.8bn of share- based compensation, in their estimates. If we include the impact of share-based compensation in Intuit’s 2023 EPS to make a more
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apples-to-apples comparison with Microsoft based upon GAAP EPS, Intuit’s 2023 EPS would be closer to $9, meaning that the shares would be trading at a multiple of about 43 times. I think investors and analysts may find a premium of 14% for Intuit over Microsoft (28.4 times versus 25.0 times) to be reasonable. I’m not so sure they are fully aware that Intuit shares are actually trading at a premium of 73% if share-based compensation is treated in the same manner between the two companies.”

Bobacaca - Adjusted EBITDA removes the cost of SBC from the accounts when shares are issued so they pretend these costs are of no consequence to anyone. The P&L statement has to take into account SBC costs, and to Buffett and others (and me) they are the only ones that are of interest to a shareholder. Adjusted figures are a delusion Imho. I only look at the numbers that obey accounting rules and these were audited. Any others numbers, including the adjusted numbers, hav no rules attached.

If you study Buffett’s deliberations expressed in his annual letters to shareholders he does not differentiate between growth and value stocks in the way they are evaluated. But he does like to invest only when the future outcome has a greater probability of being achieved. In other words he does not like taking bets on future outcomes when there is no track record.

One of the difficulties with SBC that dilutes the shares is that from a company perspective the payment is indeed free, as all they need to do is “print” share certificates. So companies like to present two sets of numbers just to confuse - the accounting numbers and a parallel set. But each share held by a shareholder loses value as a result so they are paying for it through a form of forced rights issue in which they have no say.

Some companies like Microsoft don’t adjust their numbers even though they do issue shares to a limited degree. Much clearer - much more honest - much less confusion.

CAVEAT EMPTOR

At time like these it is worth taking note of some advice from Winston Churchill: ‘If you are going through hell, keep going’.

‘one thing you can't do is reduce market expectation and hope the share price stays the same”

Spot on Mr Picky - thanks for posting and sharing your thoughts.

Revenue growth rate crowdstrike 65%, sentinelOne 100%Plus, DT 30% (Revenue not ARR). This is why I say not awe inspiring. These are the competitors so the market is there to achieve much higher growth rates than currently being achieved by DT. They were accelerating for DT after IPO but that rate of growth ( and I mean rate of change of growth not growth per se)is reversing, good as the resulting numbers may seem.

There will be few winners in the race, and, although they are doing quite well now, the need to clearly demonstrate that they can outrun the competition. I believe they have the technology, but …….

The question to be considered is what revenue growth rate and ensuing Free Cash Flow is needed to support the SPs we have been seeing over the last year?

Market guidance? Are you talking of guidance by an analyst? Do they have access to information any different from that in the public domain? Have you studied the underlying assumptions on which these numbers are based? Do you believe them?

Mr Market is crazy at times but sometimes he has information we PIs do not have access to. We need to understand why.

Unless I missed it, I do not recollect that DT gave any guidance on net profit. And the guidance on future revenue growth is not exactly awe inspiring as it is now decelerating from 45% growth rate FY22 to 30% now. The question is where is it heading in 2,3 to 5 to 10 years from now as that will determine its valuation using DCF analysis.

I would have thought Bitcoin would be just your cup of of tea, Charles. No intrinsic value, no interest, and no country to peg its reputation to - so it is free to float to any height the greater fool thinks it could go or fall to any level the lesser fool feels it should sink. But you may be right - the speculative game maybe returning.

The net profit of a company is of course important, but to me it is the cash flow that determines its value of a company in the long run. Forgetting about the the complications of share based compensation for the moment, FCF it is the money left over ofter all costs are accounted for. Buffett calls it the “owners funds” and can be used to pay dividends, pay for share buybacks or accumulate as cash assets on the balance sheet increasing equity.

To me it is conceptually similar to the interest payable on cash deposits or bonds - it is the money made based on the money invested.

It can be calculated from net profit by:
1. Adding back the depreciation/amortisation
2. Subtracting any expenditure on maintenance capital items (CAPEX)
3. Subtracting any change in net working capital

Now this is where the working capital becomes interesting for high growth, subscription based, companies like DT as the working capital is negative. So subtracting a negative number (minus minus = positive) means the change in working capital adds to the free cash flow calculation.

This is because working capital (the cash tied up in a business) is defined as current assets minus current liabilities (excluding cash). Normally this is positive for most companies - the current assets being greater than the current liabilities. But companies like DT with a subscription service get paid up front. These revenues cannot be included in the profit and loss account until the service is provided so they are entered as current liabilities on the balance sheet. As these are large relative to the assets, the working capital becomes negative.

So with negative working capital the free cash flow grows relative to net profit and the more so the greater the growth rate of the company. The opposite becomes true If the growth rate becomes negative. It means that even if the net profit is negative, a company can still generate lots of cash and DT does.

Clear as mud? A better explanation for anyone interested can be found by financial experts using layman’s language.

https://finance-able.com/negative-working-capital/

A review on Buffett’s views on compensation, - he is for it but not in the way it is done at DT,

Quote
For Buffett, executive bonuses can work to motivate people to go above and beyond, but only when they’re closely tied to personal success in places within an organization where an executive has responsibility.

Too often, for Buffett, executive compensation plans impotently reward managers for nothing more than their firm’s earnings increasing or a stock price rising — outcomes for which the conditions were often created by a previous manager.

“At Berkshire… we use an incentive-compensation system that rewards key managers for meeting targets in their own bailiwicks,” Buffett wrote in his 1985 letter. “We believe good unit performance should be rewarded whether Berkshire stock rises, falls, or stays even. Similarly, we think average performance should earn no special rewards even if our stock should soar.”

At Berkshire Hathaway, Buffett enforces an individualized system of compensation that rewards managers for their personal actions — even if that means, counterintuitively, rewarding managers of individual units when the wider business doesn’t do well.
unquote

It goes on to explain why compensating in stock is not the the way to do it. For those interested his 1985 letter is worth a read as are his follow-up letters on the matter.

W007. Share buybacks are normally paid for with excess free cash flow or accumulated cash from the balance sheet (or debt) so yes from below the bottom line.

Staff need to be compensated in some way to further the interests of the owners. I remain unconvinced that share issues ate the best way.

So normal salaries and cash bonuses etc are paid for out of revenues in the profit and loss account.

Share buybacks are paid for out of current below the line cash flows or reserves. But any share buyback is only “good” if the price paid for the shares is below the intrinsic value of the shares -often not the case. But in this case I think it is a good time to do it.

Share issues are paid for by a stealth raid on the intrinsic value of shareholder’s shares through dilution. The very opposite of a share buyback and share cancellation.

Compensation with shares is supposed to tie in the interests of the management with the shareholders. I’m not convinced it does. It certainly makes an already complex series of accounts even more complex and opaque to most PIs.

And bonuses are supposed to reward management for exceptional performance. In the case of the CEO and CFO -of DT they are rewarded if the SP gains exceeds that of the FTSE350. If that is outstanding performance I don’t understand the meaning of stretch.

Share buybacks are good when the bought shares are cancelled and the shareholders’ shares are concentrated. This a way of giving money back to the shareholders. If shares are bought back and issued to staff the shares in issue remain the same. DT has been paying for SBC by diluting shareholder shares.

From my point of view I agree it is far better to buy the shares in the market and then issue them to staff as it keeps the books clear and transparent. And far better to buy back when the prices are low and not when they are high.

Terry Smith. in his recent annual report to shareholders, spent pages riling against SBC diluting shares and indirectly destroying shareholder value by stealth. Buffett takes a similar view. Smith sold Intuit recently mainly because Intuit’s over use of SBC.

Good to see more debate on this bb on the fundamentals of the company - but when it comes to future projections they can only be estimates at best - whether those are based based upon own research or that of others. Nobody can accurately predict the future even those in “in the know”. And the only people who could realistically make the most informed judgement are the directors and management who have all the current facts. All others - including ourselves - should only have access to publicly available information. There are leaks, of course, but insider trading is a crime.

Some say the market is efficient because we all have access to the same information - I disagree. But we all make our own judgements, place our bets, and hope we get it right.

I still believe in the potential of DT - some corporate governance issues aside - but DT faces stiff competition, and in the end there will be few that make it to the medal podium. Will DT be on that podium is my ongoing question? . And will it be the Microsoft, Amazon os Google in gold position of the cyber security space? Only time will tell.

Grottyface - I share your concern regarding SBC costs.

The $47m SBC cost reported by DT in F T22 is a direct raid on our shareholder value by issuing shares that reduce the intrinsic value of the existing shares. These costs are accounted for in the Reported profitability figures but are excluded from the adjusted profitability and free cash flow figures which DT seems to focus on in their reporting. It is a stealth raid on shareholder value as shareholders have little say.

The stupid thing is that the greater the SBC cost, the greater is the positive difference between the net profit figure (that takes into account SBC costs) and free cash flow figures (that don’t). This is crazy.

I liken it to governments printing money which fuels inflation - and hence destroying the wealth of those with money.

To me the bottom line figures of relevance are the net profit and the free cash flow - not the FCF figures reported by DT but those that exclude the SBC costs and exclude some of accrued revenues reported as liabilities on the balance sheet. (I.e those received but the service not yet provided). Some of the numbers reported by DT that not covered by accounting rules are not what I would normally expect them to be. DT is not alone on this - smoke and mirrors. Caveat Emptor.

A strengthening sterling results in fewer pounds when converted back from dollars - surely? At a fx of 1.1, one dollar converts to 91p and at a fx of 1.2 converts to 83p.

I expect tHE update will be next week - last year 11 Jan. They will always be pre-open of the LSE.

Touché SW77 - the only time the SP is of interest to me, too, is if I want to buy, or sell, a piece of the Business when the SP is below, or above, its deemed intrinsic value. But, to me, it is also of interest to know what drives Mr Market to behave irrationally, and so allow for these opportunities to buy or sell at prices widely differently from that intrinsic value. Were Mr Market to be “efficient” these opportunities would not exist.

And over 1month DT has fallen the most when compared with the other two, but again the least over 3months and y-t-d, Last Friday’s fall will have had a “special” cause - possibly shorting activity or equally possible a larger investor wanting to unload a chunk of shares for any other reason.

Or just “normal” trading activity when Mr Market is unhappy and causing ongoing supply-demand imbalances. The SP movements of DT are similar to most growth stocks in the short term.