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What divides profits from losses? Interpretation

Tech’s compensation conundrum

Is Twitter making money or losing it? The question may sound straightforward, but for the troubled tech company and others, it all comes down to interpretation.

For instance, according to the earnings numbers reported by much of the press and used by analysts, Twitter made $67 million in the third quarter, or 10 cents per share. But when the company computes its bottom line according to generally accepted accounting principles, it finds that it had a loss of $132 million, or 20 cents per share.

The biggest difference between the two numbers the company provides is due to stock-based compensation, or the value of the Twitter shares and options that the company gave its employees as compensation in the quarter. That expense totaled $166 million, or 30 percent of the company's revenue.

Read More Why Jack Dorsey may not be able to fix Twitter: Analyst

While the Financial Accounting Standards Board considers this to be an expense that must be logged in the quarter, cutting into profits, Twitter is not alone in thinking differently.

For instance, Amazon's earnings press releases highlight operating cash flow and free cash flow. It even begins the official presentation of its results with its statement of cash flows, which a company usually presents after its income statement and balance sheet. This is where it shows that, in the most recent quarter, its $79 million in net income would have been $623 million had it been able to forget about stock-based compensation.

And Valeant, whose accounting methods have come into question, draws investors' eyes to what it calls "Cash EPS" — an earnings-per-share measure that added back in, among other much larger expenses, $15.5 million in share-based compensation for the third quarter.

While it may sound like companies are purposely obfuscating poor results, the creative accountants behind the numbers do have a point.

Official accounting standard for share-based compensation have varied over time. Starting in 2006, companies were forced to record the options contracts they dole out to employees (which allow employees to benefit from a rise in the company's stock) as expenses, which appears to have cut down on the use of options as payment.

And ignoring this large noncash charge can provide a net income number that is more closely aligned with a company's cash flow. For instance, between operating and investing activities, Twitter saw $23 million in net cash inflows for the quarter, which is quite close to the company's net loss after share-based compensation expense is added back in.

But investors likely ignore the cost of stock-based payments at their own risk.

"There are no free lunches and if a company chooses to pay $5 million to an employee, that will affect the value of my equity, no matter what form that payment is in (cash, restricted stock, options or goods)," NYU stock-valuation guru Aswath Damodaran wrote in a 2014 blog post.

Of course, those who work at the hot young tech companies that frequently lean heaviest on this technique have become well used to such workplace perks as free lunches.

"We deal with this problem a lot at Manhattan Venture Partners," said economist Max Wolff. "We generally tend to touch and handle companies two or three years before they go public all the way through the lockup expiry six months after they go public. And part of what we see, especially in the tech world, is companies that are having a hard time going into the harsh light of day as a public company are used to growing up in the private company space, where everything's really 'the benefit of the doubt,' 'pro forma,' and you can massage things almost to the point of irrecognizability and still be OK."

"We're seeing a real hard time making that transition, and stock-based comp is big since it's a lot of how you pay folks, and if you can sweep that under the rug — sure, there's a bulge in the rug, but it does make things look a lot nicer," Wolff continued.

Correction: An earlier version of this article misstated the size of Valeant's adjustment from net income per share to cash EPS that can be attributed to stock-based compensation expense.