How Brilliant Managers Still Make Shareholders Poorer

There are capital allocation mistakes that even the smartest management teams commit.

The primary role of management in a company is simple: Provide shareholders with the best rate of return.

This requires operational excellence, profitability, and most importantly, the prudent allocation of capital.

Reaching the helm of a listed company is the pinnacle of professional ambition for many people, and therefore only the very smartest people in the world are selected to be leaders of listed companies.

Yet despite the undeniable talent that leaders must exhibit to get into the role, some leaders still tend to do things that are not optimal for shareholders.

In my years of investing, I’ve identified two areas where even the “smartest” consistently fail shareholders.

Buybacks

One of the most common value-destroying “habits” of management is to buy back shares at bad prices.

Although buybacks are not inherently bad for shareholders, it is extremely price-sensitive.

When a company buys back shares, it reduces the share count, increasing the ownership of remaining shareholders.

The goal of buybacks is to be able to provide remaining shareholders with higher future dividends per share, eventually. Sounds great, but there’s a catch.

If buybacks are done at a very high valuation, the number of shares that the company can retire from buybacks drop. This reduces its impact.

And buybacks have a cost- it is paid for by the company’s cash coffers. That war chest can be used for many things such as acquiring another business, paying a dividend or simply being stored on the balance sheet to be used during opportune times. All of these could be better uses of cash than buying back shares at high prices.

Too often I notice companies guide toward a certain amount of buybacks for the year. This means that the company plans to use its cash to buy back shares during the year no matter the price of the shares at that time. This is lazy and can be detrimental to shareholders if share prices rise to an unsustainably high price.

A better way to do it would be to only buy back shares when shares are cheap or trading close to “intrinsic value”.

A rare example of a leader that bucks this trend is August Troendle of Medpace (NASDAQ: MEDP). Under his guidance, Medpace has only repurchased shares at prices that August deems cheap. He has even directed Medpace to take on debt to buy back shares when prices are cheap. He has let cash pile up on the balance sheet when share prices rose too high.

Stock-based compensation

Stock-based compensation is the practice of paying employees in stock.

I’ve written in depth about some of the drawbacks of stock-based compensation here. While often marketed as aligning incentives, stock-based compensation can be very dilutive.

This is especially true when stock prices are depressed.

When stock prices are low, the number of shares that a company needs to grant is higher in order to satisfy an employee’s wage demands.

Yet, management teams seem indifferent to this, actively using stock-based compensation despite these nuances.

I believe stock-based compensation has a role, especially as a way to incentivise top leaders of a company.

But using stock-based compensation across the entire company and through different cycles of the company is lazy management.

Leaders need to rethink their total rewards framework. If they must give employees stock-based compensation even when shares are cheap, it is important that leaders find a way to manage dilution, perhaps through opportunistic buybacks.

Constellation Software (TSE: CSU) has a great compensation structure for executives that avoids this conflict. It does not provide traditional stock-based compensation. But to align leaders with shareholders, executives need to invest 75% of their bonus into Constellation Software’s common shares. These shares are held in escrow for four years so that executives’ wealth is also inextricably tied to shareholders.

Bottom line

Top executives are paid top dollar to run a company to maximise shareholder value. Yet elite leaders continue to do things that erode investor wealth. As shareholders, we can’t control what managers do but we can choose where we deploy our capital.

When we see a management team unwittingly destroying shareholder value, either through “lazy” buybacks or broad-based stock-based compensation, take it for what it is – a massive red flag.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in Medpace. Holdings are subject to change at any time.

3 Things That May Drag a REIT’s Distribution Per Unit Lower

Look under the hood at a REIT’s financials to understand if its future distributions are at risk of a decline.

Singapore-listed REITs, or real estate investment trusts, are a favourite investment vehicle for many Singaporean investors.

REITs provide investors with the opportunity to invest in property and also provide much more liquidity than investing directly in real estate. In addition, many REITs in Singapore have juicy trailing distribution yields that can be as high as 9%. And with interest rates likely on the decline, REITs can also benefit from lower interest expenses and so can have higher distributions to unit holders.

Given the above, I did some research on REITs recently to see if there were any that might be attractive opportunities. But as I conducted my study, I noticed some common issues about REITs that may end up being a drag on their future distributions per unit.

Here’s what I found.

Management fees that are paid in units

A common theme I noticed about REITs in Singapore is that most of them pay the bulk of the REIT manager’s fees with units in the REIT.

Take a look below at Keppel DC REIT’s (SGX: AJBU) financial statement for the first half of 2025. They show the adjustments made to Keppel DC REIT’s net profit to determine the income available for distribution. One of the adjustments made is the management fees paid in units.

*Source: Keppel DC REIT 2025 first-half financial statement*

To prop up a REIT’s distribution per unit (DPU), a REIT’s manager can choose to receive its fees in units of the REIT instead of cash, since doing so means cash can be returned to shareholders. But this will be a drag to a REIT’s DPU over the longer term for two reasons.

First, once the REIT’s manager opts to receive all or a bigger portion of its fees in cash, the amount available for distribution to unitholders will decline (all other things remaining constant). Second, because the REIT manager opted to receive its fees in units in the past, the REIT had to issue new units, which resulted in a higher unit count; future distributions are thus divided across a larger unit base.

Keppel DC REIT is not the only REIT that does this. In fact, it is common practice across REITs in Singapore.

Sasseur REIT (SGX: CRPU) is another example. Take a look at the REIT’s condensed income statement for the first half of 2025:

*Source: Sasseur REIT 2025 first-half earnings presentation slide*

The base fee of Sasseur REIT’s manager that is paid in cash increased by S$0.4 million from the first half of 2024 to the first half of 2025. This is because the REIT manager opted to receive 30% of its base fee in cash in the first half of 2025, rather than the 20% it chose for the first half of 2024. This is a real case of how the DPU of a REIT can decline simply because a REIT’s manager chooses to receive less of its fees in cash.

The way I see it, the DPU of Sasseur REIT is being propped up by the REIT manager’s decision to receive some or all of its fees in units rather than cash. Once this goes away, DPU will be pressured.

Another example is Frasers Logistics & Commercial Trust (SGX: BUOU). These are the adjustments the REIT made to obtain its distributable income:

*Source: Frasers Logistics & Commercial Trust’s FY2025 first-half financial statement*

For Frasers Logistics & Commercial Trust, the column on the right of the table refers to the first half of FY2024 and the column on the left refers to first half of FY2025. In both periods, the REIT added a significant amount of “management fees paid in units” to net income, which puffed up distributable income. But in the first half of 2024, 100% of the REIT’s management fees were paid in units while in the first half off 2025, only 43% was so. Because of this change, Frasers Logistics & Commercial Trust had a lower upward adjustment to distributable income in the first half FY2025, which was one of the reasons its DPU to shrank year-on-year.

Watch for capital distribution

Another thing to look out is whether the DPU is being bumped up by one-off or short-term capital distributions. We can return to Frasers Logistics & Commercial Trust as an example.

*Source: Frasers Logistics & Commercial Trust’s FY2025 first-half earnings presentation*

The image above shows that Frasers Logistics & Commercial Trust’s total distributable income were bumped up by capital distributions in both the first half of FY2025 and the first half of FY2024.

The problem is capital distributions are one-off, or short-term distributions, and are dependent on gain on divestments. A REIT’s manager may decide to retain or distribute capital gains depending on the REIT’s performance for the year in order to “smoothen” out distributions. But as investors, we should note that these are not long-term solutions and eventually this capital distribution buffer may run out.

We can look at Far East Hospitality Trust* (SGX: Q5T) as an example:

*Source: Far East Hospitality Trust’s 2025 first-half earnings presentation*

Far East Hospitality Trust’s distribution to stapled security holders include distributions from other gains. The stapled trust divested one of its properties in 2022 and has since been distributing the divestment gains to unitholders at around S$8 million annually; the manager of the trust had decided to distribute the divestment gains over a few years to smoothen the trust’s distribution per stapled security (DPS). But as with all capital distributions, the well will eventually run dry, and absent the capital distribution, the DPS will likely drop.

*Far East Hospitality Trust is technically not a real estate investment trust. Instead, it is a stapled trust consisting of Far East Hospitality Real Estate Investment Trust and Far East Hospitality Business Trust. But for the purposes of this article, there’s no need to split hairs.

Interest rate sensitivity

When looking at how sustainable a REIT’s DPU is, we also need to look at its interest rate sensitivity. REITs have been reporting rising finance costs in the last few of years as their debt gets refinanced at higher rates or as their floating rate debt gets repriced. The rising finance costs have been a drag to their DPU.

This why I prefer a REIT with a high interest coverage ratio. A higher interest coverage ratio means that a change in interest rates would have a smaller impact on distributable income.

Imagine a REIT with an interest coverage ratio of 5. All else equal, a 20% increase in finance costs will only lead to a 5% decline in DPU. Comparatively, a REIT with an interest coverage ratio of 3 will suffer a 7% decline in DPU.

CapitaLand Integrated Commercial Trust (SGX: C38U) has an interest coverage ratio of 3.3, shown in the table below, which looks fairly low to me and suggests that the REIT’s DPU is sensitive to interest rate hikes. But we are in a fairly high interest rate environment at the moment, so it is perhaps more common for interest coverage ratios to be on the lower end of the spectrum during this time.

*Source: CapitaLand Integrated Commercial Trust 2025 first-half earnings presentation*

Final Takeaways

Singaporean investors invest in REITs for steady income.

Although Singapore-listed REITs have historically performed decently, investors still need to assess if a REIT’s DPU can be sustained in the long-term. To do so, they can peer under the hood and determine if the REIT’s DPU could be pressured by (1) a higher unit base, (2) the end of capital distributions, and (3) the end of fees being paid in units.

It is also important to assess how sensitive a REIT’s DPU is to interest rate spikes. Rates may be likely to be on a downtrend in the near future, but there may be times ahead when interest rates spike again.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I don’t have a vested interest in any company mentioned. Holdings are subject to change at any time.

Does Grab Holdings’ Recent Convertible Note Offering Make Sense?

Management teams that can make use of opportune pricing of stocks and debt can greatly increase the returns of shareholders.

Grab Holdings (NASDAQ: GRAB) recently announced that it would be raising cash through a convertible note offering. This came as a surprise to investors as Grab still has lots of cash on its balance sheet.

But if you look at recent history, it is not uncommon to see companies raise cash when the cost of capital is relatively low, even when they have sufficient cash on their balance sheets.

Companies such as Zoom Communications (NASDAQ: ZM) and Tesla (NASDAQ: TSL) raised cash through a secondary offering in 2021 when their stock prices went hyperbolic.

With stock prices rising to new all-time highs again, we could potentially see more companies taking advantage of favourable market conditions to raise cheap capital. With that in mind, I thought it would be a good time to share some quick thoughts on such capital raises.

Understanding cost of capital

The question of whether a company should raise capital boils down to whether the returns earned on the capital exceed the cost of capital.

But there is a lot of confusion over what the cost of capital is. For debt issuance, the cost of capital is simply the interest that is paid on the debt. For equity issuance, the cost of capital is a lot more complicated.

There are a few schools of thought when it comes to calculating an equity’s cost of capital. I like to keep things simple – and the simplest way to think about it is by assessing the impact on future returns to shareholders on a per share basis. For instance, if a company needs to issue 300 shares and has 1,000 shares outstanding, the cost of capital is 30% of the company. To make the share issuance worthwhile, the company needs to ensure that the money raised will be able to increase the future stream of cash returned to shareholders by at least 30%.

So a company that is projected to return $1 per share to shareholders for eternity will require the cash that is raised to increase that return-figure to at least $1.30 to justify a share issuance that dilutes shareholders by 30%.

Does Grab’s issuance make sense?

With this in mind, let’s take a look at Grab’s recent note offering. Last month, Grab announced that it would be raising US$1.5 billion through a zero coupon convertible note offering.

Convertible note offerings are debt offerings in the sense that the money needs to be paid back. But because it is convertible, these notes can potentially be turned into equity. In Grab’s convertible note offering, the debt can be turned into equity if its stock price trades above the conversion price of US$6.55. If the conversion happens, Grab does not need to pay back cash to the note holders but the new shares will become dilutive to existing shareholders.

Let’s assume that all these notes will be turned into equity. As of end-2024, Grab had a fully diluted share count of 4.3 billion shares (including warrants, unvested restricted stock units, and options). The note offering, if converted to shares, will result in 229 million new shares being created, which means 5.3% dilution. In other words, for the convertible note offering to make sense for Grab, it needs to use the proceeds to increase its future cash returned to shareholders by at least 5.3% per share.

This can be done in two ways: (1) Grow the cash generated by the company by more than 5.3% or (2) decrease the share count by more than 5.03% (a 5.03% reduction in share count will lead to 5.3% per share growth – you can do the math)

Grab mentioned that it could potentially use the cash to buyback shares. If they manage to do it at the current share price of around US$4.70, the company will be able to buy back 330 million shares or around 7.3% of its fully diluted share count (this includes the 5.3% dilution from the conversion of the convertible notes). This would be a massive win for the company. In essence, Grab would be able to reduce its share count even after the conversion of the convertible notes to shares, simply by using the cash raised and buying back its shares at current prices.

Grab doing a massive buyback may not be far fetched, as the company also simultaneously announced along with its note offering that it is buying back around US$273.5 million of its shares at US$4.68 each from buyers of the notes.

Bottom line

As investors, it is challenging to assess whether equity raises make sense or not. The theory mentioned above may be simple but in most cases, there are many moving parts.

Cash is also fungible, and we usually do not know where the capital went. If the company had not raised cash, which aspect of its expenses or investments would it have cut?

As an investor, instead of trying to assess where the money went, one thing that we can do is to dissect whether management teams are raising capital at opportune times; opportune times are when stock prices are high or when interest rates are low. This is when the cost of capital is the cheapest. Likewise, companies should be buying back stock when stock prices are low and holding back on debt issues when interest rates are high.

As investors, owning a strong business is one thing, but we also need management teams that are savvy with capital allocation and capital raising. Management teams that can make use of opportune pricing of stocks and debt can greatly increase the returns of shareholders.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in Tesla Inc. Holdings are subject to change at any time.

Can The (Micro)Strategy Bitcoin Playbook Last Forever?

Strategy’s amazing financial engineering.

Strategy (recently renamed from Microstrategy) is one of the top performing companies in the US stock market in recent years. The stock price of the highly controversial “Bitcoin holding company” is up 210% in the last year alone and up a staggering 3,300% in the last five years.

One reason why Strategy has done so well is because it is one of the best at raising cheap capital. How does this work?

Self-fulfilling cycle

Strategy’s Bitcoin playbook is pretty simple and yet quite ingenious. The “Bitcoin holding company” basically takes advantage of its stock price trading at a premium to book value by selling new shares for cash.

Imagine a company that has a book value of $1 million and has 1 million shares. Each share, hence, has a book value of $1. But let’s say that for some reason, someone is willing to buy the shares at $2 each. The company can take advantage of this and sell new shares to this buyer. Let’s say the company sells 1 million new shares for $2 million. After the share issuance, the company now has 2 million shares outstanding and $3 million in book value. The book value per share is also now magically $1.50. The process can become a self-fulfilling cycle where the company raising shares above book value actually leads to the book value per share increasing.

This is exactly what Strategy has done. Its book value per share has risen by using this simple financial engineering trick. But Strategy then also uses proceeds from its share issuance to buy Bitcoin. If Bitcoin’s price rises, Strategy’s book value per share will increase yet again.

In 2023, Strategy raised US$2.0 billion from issuing shares. In 2024, the company raised an even larger sum of US$16.3 billion from ordinary share sales. As of its last quarterly earnings update for the first quarter of 2025, it has raised another US$5.7 billion through sales of common shares and preferred shares.

But Strategy has gone yet one step further. The company has also raised capital through debt markets to buy more Bitcoin, in effect leveraging up its balance sheet and increasing its exposure to Bitcoin. Strategy’s total debt has increased from US$2.2 billion in 2023 to US$7.2 billion in 2024, and US$8.1 billion in the first quarter of 2025.

What the bulls believe

Investors who are bullish on Strategy believe that this virtuous cycle can continue forever. They believe that Strategy’s premium to book value will exist for many years as there are sufficient buyers of the stock who believe in this self-fulfilling cycle.

If true, Strategy will become a compounding machine simply by issuing new shares at a premium and juicing its book value per share. There’s also the Bitcoin purchases, which adds another growth-factor for Strategy’s book value per share.

But as I mentioned earlier, there’s also leverage at play with Microstrategy because the company has used debt to buy more Bitcoin that it can actually afford. Microstratregy’s book value will therefore swing more than Bitcoin’s price. If Bitcoin’s price rises, Microstrategy’s book value will go up faster.

When will the party end?

“I applaud Strategy’s playbook. But there are some risks that shareholders need to be wary of. The obvious one is if Bitcoin’s price falls. When this happens, Strategy’s book value per share will fall faster because of the leveraged nature of the company’s balance sheet. As of 31 March 2025, Strategy had US$43.5 billion worth of Bitcoin but only US$32.2 billion in equity. If Bitcoin’s price falls by 50%, Strategy’s book value would drop to US$10.5 billion, or roughly a 66% fall. For Strategy to enter negative book value territory, Bitcoin will need to fall by around 74% from the 31 March Bitcoin price.

The other major risk is if stock market participants decide that Strategy’s stock price simply does not deserve to trade at a premium to book value. In other words, buyers of the stock only want to pay book value to buy shares. This throws Strategy’s ability to raise capital cheaply out the window. But it also means that Strategy’ shareholders who first invested at a premium to book value could face a potential heavy loss.

As of Bitcoin’s price at the time of writing, Strategy’s book value is worth around US$38 billion. But based on the company’s current stock price, its market capitalisation is around US$108 billion, or a 180% premium to its book value. Even if Bitcoin’s price remains stable, but Strategy’s stock price reverts to no premium on book value, this could still lead to a painful 64% reduction in the stock price price.

For now, momentum and the current environment suggests that market participants are unlikely to bid down Strategy’s stock price so drastically so soon. But things can change during “risk-off” environments and when market participants become more cautious.

A double whammy for Strategy shareholders can happen if both Bitcoin’s price falls and Strategy’s premium to book value narrows.

The bottom line

Whatever you think about Michael Saylor and his Bitcoin views, he certainly has mastered the dark arts of financial manoeuvring. In most assets, fundamentals drive price. Saylor has managed to turn the script around, making price drive fundamentals.

But this comes with risks. If Strategy’s stock price collapses, the virtuous engine stops running. Saylor seems to be wary of these risks. While Strategy continues to issue shares to buy Bitcoin, Saylor is constantly selling his Strategy shares.

Despite the risks, market participants seem hungry for more of such companies. Besides Strategy, there are now a number of copy cats around the world, such as Metaplanet in Japan which has seen a meteoric rise in its share price this year. Its stock price is at an eye-popping 7 times book value.

For such companies, the party will end when there are no more greater fools to sell to (both for Bitcoin and for new shares of the company). Whether – or more likely, when – that happens is anybody’s guess. Just be careful not to be the last one holding the bag.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned. Holdings are subject to change at any time.

Passive Income

Knowing what you want to achieve, and what passive income is, is important

Passive income is not just income earned outside of your job. The real meaning of passive income is money that you earn with little to no effort.

Some may think that money earned in the stock market or from properties is passive income. Yet, this may not be the case. Stock market investors can sometimes be so caught up in trading and looking at stock prices that investing becomes a huge part of their lives and can even be considered another job. Property investing can also turn out to be tedious if you manage your properties yourself.

I know of friends who want to earn passive income but instead end up spending so much time on their investments. Don’t get me wrong. I love spending time learning and investing but this isn’t really “passive”.

Here’s how you can earn real passive income.

Stop trading the stock market

First, stop short-term trading. My definition of trading is buying stocks in the very short-term based on price action and charts. This is not investing and can become a part-time or full-time job as it requires a lot of time and effort. The more trades you need to make, the more effort is required.

We should aim to invest in a way that reduces the number of trades and amount of work that we need to do.

One way to do this is by investing long-term in set-and-forget investments. Investing in stocks that have the potential to grow earnings (and thus the share price) reliably over the long-term is one good strategy that lowers the time spent on investing.

You can also invest in passive index ETFs that track the performance of broad market indexes. Stock indexes have historically increased in value over a sufficiently long period of time and provide a good way to gain exposure to some of the biggest and most profitable companies.

You can also invest in dividend stocks that reliably pay a dividend. Investors from Singapore enjoy tax-free dividends when they invest in Singapore-listed dividend-paying stocks.

Outsource your investing

Another way to reduce time and effort spent on investing is to outsource your investing to an expert.

One way to do this is by employing financial experts who can advise you on stocks to buy or funds to purchase. You can also use robo advisors which can help you allocate your portfolio into a variety of investments.

While you will need to pay a fee for these services, having someone to invest on your behalf or advise you frees you from the hassle of doing everything yourself and saves you a ton of time.

Invest in other passive assets

You can also invest in other assets beside the stock market.

Assets such as long-term fixed deposits, government bonds, or even professionally-managed real estate may be a good way to grow your wealth without doing much work.

If you can find long-term investments that require little effort on your part but can provide a stable passive return, this is a potentially good asset to invest in and reduce your investment effort.

Know your goals

What do you really want to achieve? Do you want to grow your wealth as quickly as possible?

Then by all means go ahead and dig through annual reports, scour the market for undervalued stocks, sell weekly put options, or even manage your own AirBnB property for higher rental yields. There is nothing wrong with this and is my preferred style of investing.

But this is not passive income.

If you really want passive income, invest in long-term assets, find a professional or robo advisor to manage your wealth or build passive income by dollar cost averaging into funds or long-term assets.

While this may not always give you the best fee-adjusted returns, this is a true passive income strategy and frees up your time for other things in life.

Ultimately, when it comes to investing there is no one-size-fit-all strategy and knowing what you want to achieve can help determine how you should approach investing your spare capital (and time).

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned. Holdings are subject to change at any time.

Why Do Employees Love Stock-Based Compensation?

Stock-based compensation has its risks, but it can still be an attractive proposition for an employee

In the past, stock-based compensation was more common with fledging startups that had to find ways to preserve the little cash they had.

But today, stock-based compensation is used by almost every major company in the world. Even big firms with lots of cash continue to use stock-based compensation. One reason is because employees want to get paid in stock.

How it works

To understand why this is, we need to look at the mechanics of how stock-based compensation works.

In a typical compensation package, an employee may be offered an annual contract with, say, 33% of the compensation coming in the form of restricted stock units and the rest in cash. This means that an employee who is on a $100,000 annual package will get $33,000 worth of shares per year.

But here’s the catch. This $33,000 worth of shares is based on the share price at the time of signing the employment contract. If the share price rises, the amount that the employee receives each year will be more than $33,000.

For instance, many Nvidia employees who were hired before the massive run up in its stock price the last few years are now receiving shares every quarter that are worth so much than when they joined the company.

Here’s how the math works. Let’s say you were hired by Nvidia five years ago. Back then, its shares were trading at a split-adjusted price of US$6.10 each. You were given a US$200,000 annual package for five years that consists of US$134,000 in cash and US$66,000 in stock . Using the stock price of US$6.10, the US$66,000 in stock-based compensation means you will receive 10,819 shares each year. The number of shares that you receive each year is fixed, even if the stock price goes up or down. Fast forward to today, and that 10,819 shares that you receive each year is now worth US$1.1 million.

Typically, stock grants only last for a few years before they expire and new grants will be made at the current stock price. This is why some employees may want to leave the company after the stock price has run up a lot and they have collected all their shares from the initial grant.

Stock-based compensation lets an employee enjoy the potential upside from a company’s stock without having to put down their own capital to buy shares. For instance, you, the Nvidia employee who was hired five years ago, essentially “bought” US$330,000 (US$66,000 multiplied by 5) worth of Nvidia shares five years ago. That’s a huge bet for most people, but stock-based compensation allows an employee to enjoy the returns of this bet without actually having to buy shares.

Potential downsides

However, there are potential downsides for an employee who takes a pay package that has a significant component in stock-based compensation.

For public-listed companies, employees can sell the shares when they vest. But for private companies, the shares are illiquid and employees may not have an easy way to convert the shares to cash. In addition, employees who work for a small startup and get shares in the startup have a high risk that the startup fails and the company’s shares ends up worthless.

I know of friends who are stuck with shares in companies they previously worked for. These companies may be struggling or have no clear path to an IPO or to be acquired, leading my friends to be stuck with shares of the companies without any real means to cash out.

The risk for employees of public-listed companies who receive stock-based compensation is that the share price falls. This is the case for many US-listed technology companies after 2021, with many of their stock prices still down by 50% or more from their 2021 peak.

Imagine if you joined Okta in April 2021 and received a 4-year pay package of US$200,000 consisting of US$134,000 in cash and US$66,000 in shares. Back then the shares were trading at around US$244 each, so you would receive 270 shares per year. Today, 270 Okta shares are worth US$27,049 – a materially smaller sum compared to the grant value of US$66,000. You would have been better off taking US$200,000 in all-cash compensation.

Bottom line

All things considered, despite some drawbacks, stock-based compensation is still an attractive proposition for an employee as it allows them to make a huge “bet” at the grant date stock price of a company without laying out any capital at all.

If the stock surges like Nvidia’s, then the employee could be set for life. However, if the stock fails, employees still get the cash portion of the annual pay package.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Okta. Holdings are subject to change at any time.

What Do Job Cuts Mean For Shareholders?

Job cuts can have both positive and negative consequences for a company

Recently, Meta Platforms Inc (NASDAQ: META) announced that it would cut around 5% of its global workforce. I was discussing this with a friend of mine, who is also currently working for Meta and we talked about some of the pros and cons of job cuts from the perspective of shareholders.

Let’s start with some of the pros.

Canceling unvested RSUs

When Meta cuts jobs, it also cancels all unvested restricted stock units (RSUs) that would have vested over time had the employee stayed on. The cancellation of unvested RSUs reduces the dilution from stock-based compensation.

Bear in mind, the number of RSUs granted is based on the stock price back when the RSUs were granted, and not when they vest. Back in 2022, Meta granted a huge number of RSUs as refreshers because of its lower stock price. For context, Meta granted 59 million RSUs in 2021 (when its stock price was high) but because of the refreshers and low stock prices in 2022 and 2023, Meta granted 107 million and 109 million RSUs in 2022 and 2023, respectively.

Cancelling some of these unvested RSUs will reduce dilution. In addition, hiring new employees and granting new RSUs will not result in as much dilution because Meta’s stock price is now around 7 times higher from the lows seen in 2022.

Getting better talent/ motivate existing employees

Meta cut jobs based on performance. By cutting low performers and hiring new employees, Meta could potentially improve the quality of its talent.

It also keeps current employees on their guard and creates an environment where employees work hard to ensure that performance reviews are good. This prevents employees from simply coasting through work and collecting wages without adding much value to the company.

Reducing the wage bill

Wages are one of the largest expenses for a company such as Meta. Although it is likely that Meta will eventually replace the employees that were removed, the company seems intent on keeping the team lean.

In 2022, Meta cut 11,000 employees, or 13% of its workforce and in 2023, the company cut an additional 10,000 employees as it strived for a “year of efficiency”.

For perspective, Meta’s head count declined from 86,482 in 2022 to 74,067 in 2024, despite revenue climbing 41% in two years from US$116.6 billion to US$164.5 billion. This, together with operational leverage, resulted in net profit margins rising from 20% in 2022 to 38% in 2024.

But, employee cuts could potentially end up with undesirable side effects. Here are the cons.

Lower risk taking

Cutting staff based on performance can lead to less risk-taking and innovation. This is because if the employee embarks on a more innovative but risky project that ends up failing, his or her performance may be considered poor.

This may lead employees to be less innovative or to take a safe approach when it comes to projects, creating an environment of lower innovation.

Internal competition

Another potential side effect is employees may start competing with each other. This may result in less collaboration and senior staff may be less willing to train new employees as they view them as competitors to their job.

This can create a toxic work environment.

Final thoughts

Job cuts are difficult for those impacted. However, it may also be a necessary way for companies to reduce expenses and to ensure that the company remains competitive.

Looking from the lens of a shareholder, I believe job cuts can be a good thing if done correctly and can also lead to more efficiency, more profits and eventually more dividends.

However, my discussion with my friend has also opened my eyes to some of the negative impacts of workforce reduction. Companies that do layoffs need to consider these factors and try to ensure that some of these potential negative side effects do not have a huge impact on the company.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Meta Platforms Inc. Holdings are subject to change at any time.

The Pitfalls of Using IRR

IRR is a useful calculation but it has its limitations.

The internal rate of return (IRR) is a commonly used metric to estimate the profitability of an investment. It can be used to assess whether an investment is worth making or not. It is also used to assess the performance of investment funds, such as venture capital and private equity funds.

However, an IRR can be somewhat misleading and actual returns can differ significantly from what the IRR shows you. This is because the IRR only calculates the return on investment starting at the point when cash is deployed. In many funds, cash may not be deployed immediately, which results in a cash drag that is not accounted for in the IRR calculation.

The IRR also makes an assumption that the cash generated can be redeployed at the calculated IRR rate. This is often not the case.

Here are some examples to illustrate these points.

Cash drag

Venture capital and private equity funds are unique in that investors do not give the committed capital to a fund immediately. Instead, investors make a commitment to a fund. The fund only asks for the money when it has found a startup or company to invest in; this is called paid-in capital, which differs from committed capital.

To calculate returns, venture capital and private equity funds use the IRR based only on paid-in capital. This means that while the IRR of two venture funds can look the same, the actual returns can be very different. Let’s look at two IRR scenarios below:

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	IRR
Fund A	-$1000	0	0	$2000	0	0	26%
Fund B	0	0	-$1000	0	0	$2000	26%

Both Fund A and Fund B have an IRR of 26%. The difference is that Fund A deployed the capital straight away while Fund B only found an investment in Year 3. Investors in Fund A are actually much better off as they can then deploy the $2000 received in Year 3 into another investment vehicle to compound returns. Fund B’s investors, meanwhile, had a cash drag with committed capital that was not deployed in Year 1 and 2, and this drag is not recorded in the IRR calculation.

Wrong assumptions

The IRR formula also assumes that the cash returned to investors can be redeployed at the IRR rate. As mentioned above, this is not always the case. Take the example below:

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	IRR
Investment A	-$1000	$300	$300	$300	$300	$300	15.2%
Investment B	-$1000	0	0	0	0	$2025	15.2%

In the above scenario, both Investment A and Investment B provide a 15.2% IRR. However, there is a difference in the timing of cash flows. Investment A provides cash flow of $300 per year while Investment B provides a one-time $2025 cash flow at the end of Year 5. While the IRR is the same, investors should opt for Investment B.

This is because the IRR calculation assumes that the cash flow generated can be deployed at similar rates as the IRR. But the reality is that oftentimes, the cash flow can neither be redeployed immediately, nor at similar rates to the investment.

For instance, suppose the cash flow generated can only provide a 10% return. Here are the adjusted returns at the end of Year 5 for Investment A

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	IRR
Investment A	-$1000	$300	$300	$300	$300	$300	15.2%
Investment A (adjusted)	-$1000	0	0	0	0	$1832	12.9%
Investment B	-$1000	0	0	0	0	$2025	15.2%

I calculated $1832 by summing up the cash flows with the extra returns generated by investing the cash flows at a 10% rate. As you can see, after doing this, the returns generated from investment A now fall to just 12.9% vs the 15.2% previously calculated.

The bottom line

Using the IRR to calculate investment returns is a good starting point to assess an investment opportunity. This can be used for investments such as real estate or private equity funds.

But it is important to note the limitations of the IRR calculation. It can overstate or understate actual returns, depending on the timing of the cash flows as well as the actual returns on the cash generated.

A key rule of thumb is that the IRR is best used when cash can be deployed quickly so that there is minimal cash drag, and when the cash generated can be deployed at close to the IRR of the investment. If this assumption does not hold true, then a manual calculation of the returns of the investment need to be made by inputting the actual returns of the cash generated.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned. Holdings are subject to change at any time.

Applying The Lessons Learnt From 2021

Don’t make the mistakes of the past.

With stock markets making new highs this year, it is a good time to look back at the lessons learnt from the collapse of some tech stocks in 2021 and 2022.

Back then, stock markets also reached all-time highs but many tech names collapsed as valuations compressed and growth stalled.

With this in mind, here are some of the key things to be mindful of today as we navigate the stock market.

Don’t celebrate too soon

Investing is a long game. Just because our stocks have risen does not mean we have won the game. The true test of a business’s strength is its enduring ability to keep on growing. Stock prices may also reflect unwarranted short term optimism which does not materialise.

Make sure to continuously assess the fundamentals of your portfolio companies even (especially) if its stock price has skyrocketed.

Don’t chase stocks

It may be tempting to buy stocks that have risen greatly in a short period of time. Afterall, none of us want to be left out of a massive rally.

But this fear of missing out can work against us as stocks don’t keep going up forever. Remember that valuations matter and we need to assess if a stock has gone up too much over a short period of time.

In 2021, many stocks rose to unsustainable valuations, only to come crashing down to earth in the next two years. While some have recovered, many still linger up to 90% off their all-time highs.

Sell if valuations don’t make sense

Buy-and-hold is a great strategy when markets are working smoothly and you’ve bought into great growing companies at reasonable valuations.

But when stock markets are not working well and stock prices rise too high due to unwarranted exuberance, it may be important to look at your sell strategies.

Back in 2021, the stocks of many companies skyrocketed. It was not uncommon to see stocks rise by up to 1,000% in a short period of time.

While some of these companies are undoubtedly growing fast and are resilient, the valuations reached a point where forward returns would likely be depressed. Unsurprisingly, many of these companies’ stocks plunged and have yet to recover.

Growth trends may not continue

It may be tempting to look at a company’s recent revenue and profit growth and assume that it can continue growing at that rate for a long period of time. The reality is that future growth trends may not always mirror the past. This is especially true for companies that have been growing at unsustainably high rates. More often than not, growth will fall back to more normal rates.

The poster boy of the COVID collapse is probably Zoom Communications. The company saw explosive growth, only for its growth rates to flat-line once the pandemic ended.

Besides Zoom, there are numerous other companies that also saw growth decelerate meaningfully as we exited the pandemic era.

These companies unsurprisingly have seen their stock prices collapse.

Look for recurring revenue

Many companies can experience significant upmarkets due to upgrade cycles or loose monetary policy which encourage unsustainable consumer and business spending. However, remember that many companies do experience significant swings in revenue because of the cyclical nature of their end-demand. This may be more true for hardware companies or those that sell big ticket items.

Companies such as Enphase, which sells solar power products such as microinverters, have seen their revenues crater as distributors struggle to clear inventory because of weak end-customer demand.

Bottom line

Although it is nice to see stock prices rise significantly in the past two years, it is important that we remember the key tenets of value investing. The above mistakes are some that many of us have made before.

This time around, let’s try to ensure that we maintain a portfolio of stocks that have good valuations and whose business can continue to thrive in good times and in bad.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I have a vested interest in Zoom Communications. Holdings are subject to change at any time.

The Buyback Endemic

Buying back stock at unreasonably high valuations is not a good use of capital and can destroy shareholder value.

Buybacks can be a good way for companies to enhance shareholder value. Share buybacks reduce the number of shares outstanding, allowing companies to pay a higher dividend per share in the future.

But not all buybacks are good. Done at the wrong price, buybacks can actually be a bad use of capital. In fact, I have seen so many companies do buybacks recklessly and without consideration of the share price.

The problem probably arises from a few reasons.

Wrong mindset

First, some executives do not have a good grasp of what buybacks are. Take this statement from Tractor Supply’s management in its 2024 second-quarter earnings report for example:

“The Company repurchased approximately 0.5 million shares of its common stock for $139.2 million and paid quarterly cash dividends totaling $118.5 million, returning a total of $257.7 million of capital to shareholders in the second quarter of 2024.”

The issue with this statement is that it lumps dividends and share repurchases in the same bracket. It also implies that share repurchases are a form of returning capital to shareholders. The truth is that share repurchases is not returning cash to long-term shareholders but only to exiting shareholders. If management mistakes repurchases as capital return, it may lead them to do buybacks regularly, instead of opportunistically.

Although I am singling out Tractor Supply’s management, they are just one out of many management teams that seem to have the wrong mindset when it comes to buybacks.

Incentives

Additionally, executive compensation schemes may encourage management to buy back stock even if it is not the best use of capital.

For instance, Adobe’s executives have an annual cash remuneration plan that is determined in part by them achieving certain earnings per share goals. This may lead management to buy back stock simply to boost the company’s earnings per share. But doing so when prices are high is not a good use of capital. When Adobe’s stock price is high, it would be better for management to simply return dividends to shareholders – but management may not want to pay dividends as it does not increase the company’s earnings per share.

Again, while I am singling out Adobe’s management, there are numerous other companies that have the same incentive problem.

Tax avoidance

I have noticed that the buyback phenomena is more prevalent in countries where dividends are taxed.

The US, for instance, seems to have a buyback endemic where companies buy back stock regardless of the price. This may be due to the fact that US investors have to pay a tax on dividends, which makes buybacks a more tax-efficient use of capital for shareholders. On the contrary, Singapore investors do not need to pay taxes on dividends. As such, Singapore companies do not do buybacks as often.

However, simply doing buybacks for tax efficiency reasons without considering the share price can still harm shareholders. Again, management teams need to weigh both the pros and cons of buybacks before conducting them.

Final thoughts

There is no quick fix to this problem but there are some starting points that I believe companies can do to address the issue.

First, fix the incentives problem. A company’s board of directors need to recognise that incentives that are not structured thoughtfully can encourage reckless buybacks of shares regardless of the share price.

Second, management teams need to educate themselves on how to increase long-term value for shareholders and to understand the difference between buybacks and dividends.

Third, management teams need to understand the implications of taxes properly. Although it is true that taxes can affect shareholders’ total returns when a company pays a dividend, it is only one factor when it comes to shareholder returns. Executive teams need to be coached on these aspects of capital allocation.

Only through proper education and incentives, will the buyback endemic be solved.