The Accounting Tack
That Makes PayPal’s Numbers Look So Good
AUG. 4, 2017
Dan Schulman, chief executive of
PayPal, taking a selfie after his company’s initial public
offering in July 2015.
Andrew Gombert/European Pressphoto Agency
Schulman, chief executive of PayPal, taking a selfie after his
company’s initial public offering in July 2015. Credit Andrew Gombert/European
Investors liked what they saw in PayPal’s second-quarter financial
results, reported by the digital
and mobile payments giant on July 26. Revenues grew to $3.14 billion
in the quarter that ended in June, an increase of 18 percent over the
same period last year. Total payment volume of $106 billion was up 23
percent, year over year.
PayPal’s favored earnings-per-share measure — which it does not calculate in
accordance with generally accepted accounting principles, or GAAP — came in at
46 cents per share, 3 cents more than Wall Street analysts had expected. The
company has trained investors to focus on this number, rather than on the less
pretty GAAP-compliant numbers most companies are judged by. And
focus they did.
analysts’ estimates — “beating the number,” in Wall Street parlance — is crucial
for any corporate leader interested in keeping his or her stock price aloft.
Even the smallest earnings miss can send shares tumbling.
Examining how a
company meets or beats analysts’ estimates, therefore, can be illuminating.
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PayPal’s stock has been on a tear this year, up almost 50 percent
since January. At a recent $59, its shares are trading at over 40
times next year’s earnings estimates. It is clearly an investor
darling, providing all the more reason to dig into its numbers.
factors contributed to PayPal’s second-quarter earnings. But one element stands
out: the amount the company dispensed to employees in the form of stock-based
stock-based compensation — which is a company expense, after all — have helped
PayPal’s performance in the quarter? Simple. The company does not consider stock
awards a cost when calculating its favored earnings measure. So when PayPal
doles out more stock compensation than it has done historically, all else being
equal, its chosen non-GAAP income growth looks better.
have required companies to include stock-based compensation as a cost of doing
business for years. That’s as it should be: Stock awards have value, after all,
or employees wouldn’t accept them as pay. And that value should be run through a
company’s financial statements as an expense.
practice at Facebook, a company PayPal identifies as a peer. In its most recent
quarterly income statement, Facebook broke out the roughly $1 billion in costs
associated with share-based compensation that it deducted from its $9.3 billion
Back in the 1990s,
technology companies argued strenuously against having to run stock compensation
costs through their profit-and-loss statements. Who can blame them for wanting
to make an expense disappear?
They lost that
battle with the accounting rule makers. But then they took a new tack:
Technology companies began providing alternative earnings calculations without
such costs alongside results that were accounted for under GAAP, essentially
offering two sets of numbers every quarter. The non-GAAP statements — called pro
forma numbers or adjusted results — often exclude expenses like stock awards and
acquisition costs. And the equity analysts who hold such sway on Wall Street
seem to be fine with them.
As long as
companies also showed their results under generally accepted accounting rules,
the Securities and Exchange Commission let them present their favored
PayPal is by no
means the only company that adds back the costs of stock-based compensation to
its unconventional earnings calculations. Many technology companies do,
contending, as PayPal does, that their own arithmetic “provides investors a
consistent basis for assessing the company’s performance and helps to facilitate
comparisons across different periods.”
technology leaders are dumping the practice. In addition to Facebook, Alphabet
said this year that it would no longer present results that excluded the costs
of stock-based compensation.
Facebook’s chief financial officer, told investors on a May conference call that
the company would report results that include share-based compensation because
it’s a true cost of running the business.
Ruth Porat, chief
financial officer of Alphabet, which is Google’s parent company,
said the same thing on a conference call in
accepted accounting principles, PayPal reported operating income of $430 million
in the second quarter of 2017. That was up almost 16 percent from the $371
million it produced in the same period last year.
But under PayPal’s
alternative accounting, its non-GAAP operating income was $659 million in the
June quarter, an increase of almost 25 percent from 2016.
So what’s to
account for the added $230 million in operating income under PayPal’s preferred
calculation? Most of it — $192 million — was stock-based compensation PayPal
dispensed to employees in the June quarter and added back to its results as
calculated under GAAP.
That was a big
jump — 57 percent — from the $122 million PayPal handed out during the second
quarter of 2016. And back in 2015, PayPal reported just $89 million in stock
I asked PayPal why
it has been ratcheting up its stock-based compensation. Amanda Miller, a PayPal
spokeswoman, declined to discuss why the company was raising its stock-based
pay, and the role the increase played in the company’s recent results. She
provided this statement: “We pay for performance and align our compensation with
how shareholders are rewarded. We believe our treatment of stock-based
compensation is broadly consistent with our peer group.”
But this isn’t
accurate, according to the companies PayPal lists as peers in its proxy filing.
At least four of those companies — Alphabet, Facebook, Mastercard and Visa — do
not exclude stock-based compensation from their earnings calculations as PayPal
Craig Maurer is a
Autonomous, an independent investment
research firm in New York. He follows payments companies and rates PayPal’s
stock an underperformer.
In a telephone
interview, Mr. Maurer was critical of how the company accounts for stock-based
pay. He said that as a percentage of PayPal’s non-GAAP operating income,
stock-based compensation has risen to 29 percent this year from 17 percent in
literally taking a cost out of their income statement, moving it to a different
line and backing it out of results,” Mr. Maurer said in an interview. “And you
can see that it’s adding significantly to their ability to meet earnings
expectations. If you backed out the difference between what we were expecting on
stock-based comp in the quarter versus what they reported, it was 2 cents of
In other words,
the increase in stock-based compensation made a big contribution to PayPal’s
results versus what analysts had been expecting.
stock-based compensation practices have another noteworthy effect: They drive
executive pay higher at the company. Here’s
The company says
it has three main metrics for calculating its managers’ performance pay each
year. One of those measures, its proxy shows, is non-GAAP net income. So, as
PayPal awards more and more stock to its executives and employees, non-GAAP net
income shows better growth. And the greater that growth, the more incentive pay
the company awards to its top executives.
insiders, at least, that’s one virtuous circle.
A version of this article appears in print on August 6, 2017, on Page
BU1 of the New York edition with the headline: Making PayPal’s Numbers
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New York Times Company