Stock-Based Compensation Isn't "Bad"
It has its pros and cons, but it's misunderstood. The Friday Filter #90
Good morning investor 👋,
Welcome or welcome back to The Friday Filter—the quality investor’s market recap.
I was thinking about Palantir recently (that expensive military software slash corporate infiltration of the U.S. government high-growth tech business), and I remembered, when writing my analysis on them, how I talked about stock-based compensation (SBC) in the dilution section.
SBC is high for the company, but I said it wasn’t a concern, and someone asked me why I said this.
“SBC is high. Why do you say it’s not a concern?”
I believe I answered this question when asked, but with earnings being released as I speak (type), I thought it would be valuable to give an all-in overview on what to think of SBC as you read through the results. (It’s not just about dilution, and it can be used for the benefit of shareholders.)
Let’s get into it. (8 min read)
Today at a glance:
The Filter;
Stock-based compensation isn’t “bad”
📄 In other news
📚 Resource of the week
Stock-based compensation isn’t “bad”
The Filter
In the beginning, God created the heavens and the Earth.
But God also created SBC, and it does serve a positive purpose.
Something you should know about SBC is that it’s not inherently bad. It’s actually not bad by itself at all, and for investors who care about growth and invest in high-quality companies with competent management (take a deep breath), SBC might actually be a good thing.
There’s some slack given to companies with high SBC, and it’s almost as if retail investors go:
“Tsk, tsk, tsk, high SBC… now I’m being diluted… looks like this company is terrible.”
And then call it a day.
Using that logic of “SBC bad” translates to all expenses of a business being, quote unquote, bad, which I think anyone reading this would agree is an irrational take on financials.
The truth is: whether a company decides to compensate its employees with $100 in cash or the share-price equivalent, it’s just choosing a different blueprint for the same product.
It’s a Coca-Cola cane sugar vs. high-fructose corn syrup (HFCS) argument with investors. Cane sugar is made up of 100% sucrose, which is broken down as 50% glucose and 50% fructose in composition. HFCS is 45% fructose and 55% glucose depending on the type. The nutritional value of a Mexican Coke vs. an American Coke, which use cane and HFC sugar respectively, is nearly identical.
Yet, because one tastes different than the other, it causes a divide.
Even though it’s nearly the same thing.
My opinion on this is that HFCS is the better option because it costs less and allows you to purchase your favourite pop or snack at a cheaper price1.
In many ways, SBC could be (and is) the better option for the business, especially for startups where SBC gives employees better incentive while also helping the company retain cash to grow, or for any company looking to save cash to grow.
Yes, SBC dilutes you, but you know what else it does?
Frees up cash for the business.
Again, employees are paid. They are compensated. Any labour has to be paid either with cash from the business, or with a piece of your ownership via SBC. If the business were to stop growing, both of these options would mean your per-share value is decreasing (you’d be losing money). (But if a company isn’t growing anymore, you’re a doorknob for continuing to hold those shares anyway.)
The reality for most high-quality businesses is that they want to grow (particularly software or high-margin tech businesses who are very familiar with SBC as a strategy to grow). And most quality businesses need cash to continue growing, but they also need labour.
The way they keep cash while also compensating workers is using SBC. It’s a better incentive than pure salary, and it helps save cash to grow.
Google is a beautiful example to dictate this (Amazon as well, but their recent 10-Q has not been released yet as I write this).
As of Q2 2025, Google (Alphabet) booked a TTM ROIC of 31.53%, and a reinvestment rate of 89.7%2. Multiply these numbers and you get an incredible 28.28% return on any new cash invested into the business.
This is the rate every dollar Google invests is growing at, hence why reinvestment is expected to cost Google about $135 billion this year ($85 billion in capex, and another ~$50 billion in R&D).
Using the same TTM data, Google has had ~$23 billion worth of SBC, while also having bought back ~$60 billion worth of its outstanding shares (offsetting the dilution by almost three times).
Now, in theory, Google does not have to offset the dilution by repurchasing its shares (even though that isn’t the primary reason they’re doing so), because growth already offsets the growth of SBC. But management decides to do that because of the massive spread (cash surplus) the company has.
My framework is simple: I buy companies that have a competitively advantaged business, typically high margins, high return on capital, and smart management who knows good capital allocation.
Dilution isn’t an issue using this checklist. Hence why I treat dilution as a secondary issue, or no issue at all in my analyses.
High-growth business > Invest cash at high returns > Save on cash by paying employees with stock, which causes dilution > Use the saved cash to grow more > Grow faster than dilution > Generate positive shareholder value long-term.
I have this consistent perspective because my research is primarily focused on the growth aspect of the business and how its fundamentals will carry based on secular trends for years. Whether or not a company decides to offer SBC and dilute my ownership or hurt earnings and EPS—none of it matters to me as long as SBC is either stagnant or is growing less than the main metric I track (usually FCF), and will continue to do so for the period I own the stock.
My mindset on research is understood over such a long period of time, and that helps me to conceptualize situations where most would put a label saying something a company is doing is a negative (like in the case of SBC).
Anyway, now that that’s out of the way, here’s a case study on SBC I’ve been watching lately:
Meta’s SBC strategy (ongoing case study)
I remember writing about Meta and its large poaching of OpenAI employees a few weeks back in Friday Filter, as well as its (wink, wink) definitely-not-antitrust-avoidance acquisition of Scale AI, and something stood out. I’ll skip the dialogue and tell you: what stood out was its use of SBC.
In this very interesting case of Meta, SBC is being used aggressively to hire employees (AI researchers, to be exact).
I believe uncontrollable SBC or consistently increasing SBC is always bad for shareholders if not backed by a viable justification (or growth).
And what I’d consider a viable justification in this case is along the lines of what Meta is doing with its AI talent strategy, which essentially comes down to poaching Google, OpenAI, Apple, Anthropic, and more, holding a stick with a carrot worth hundreds of millions within just a year or two of work.
In total, around 15-25 high-level AI researchers at top AI companies have been poached by Meta with $100 million+ signing bonuses and more annual stock compensation (and that’s just in a few months). If we assume close amount of compensation for each of these poached researchers, that gives us $2.5 billion in SBC issued for just 25 people.
Considering the high-stakes environment of current AI, I believe this is justified. The cost of losing this race or becoming a “distant place” in the leadership is huge, so taking this financial “risk” in the short term does make sense, and that’s a strategic use of SBC which benefits shareholders long-term.
Short term pain, long-term gain, if AI pans out.
This is something I’ll be watching (as close as someone who doesn’t own shares in Meta watches Meta).
See you next week.
a. 📄 In other news
Figma is such a quality company, and it just had its IPO yesterday (Thursday), zipping up over 250% on its first day of trading and raising over $1 billion. When the first 10-Q is released with more context, assuming the valuation is fine, I could definitely see myself buying.
Anthropic hits $170 billion valuation
Anthropic, maker of Claude, looked to raise $5 billion at a $170 billion valuation this week, which is almost half the valuation of OpenAI while being a less powerful model with much less brand recognition. So many AI companies raising at such high valuations is giving me the eeby-jeebies. (Amazon and Google own around ~40% of the company3.)
Novo Nordisk falls another 20%
A watchlist stock of mine I’m still learning more about. The fall was from a profit slump warning and a CEO change. I’ve heard the recent GLP trials weren’t as effective as the competition’s lately too. It’s staying a watchlist position until I know more, but interesting to see such an aggressive trend (65% down in the past year).
Google raises capex spend by 13%
Google expected $75 billion in capex spend in 2025, but now that number is expected to be $85 billion, according to management this earnings. This is old news, but since I’m on the topic, might as well mention it this week (I didn’t share it when it was announced). Great news.
b. 📚 Resource of the week
An amazing post by John that I read on Blossom Social this week (one of my main social accounts).
Not much else to explain. The title says it all.
I think it’s a valuable resource to look over; definitely worth a few minutes of your time to scroll through and read.
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That’s it for today. Thanks for reading. Enjoy the 10-Q reading, folks (I know I’ve been).
Cheers,
Jacob
All of my links here.
From the archives:
“The first $10 trillion company”:
The likely reality is the consumer doesn’t get a cheaper price and Coca-Cola pockets a higher profit, but I digress.
TTM R&D ($52.92 billion) + TTM Capex ($67.0 billion) as a percent of $133.7 billion in TTM operating cash flow.
Google owns about 14% with a cap at 15% and no board seats or voting rights having invested $3 billion, while Amazon has a cap at 33% and has invested $8 billion. I just did the math to assume Amazon’s share for the ~40% total.