The promise of rapid earnings growth that prompts some companies to pay staff with stock grants or options has become a predictor of share-price underperformance during the 2022 downturn.
Companies with stock-based compensation programs have outperformed the broader market by 9.2 percent so far this year, found Patrick Palfrey, a senior equity strategist at Credit Suisse.
The profile of such companies — mainly tech and other new public entities expected to deliver above-average earnings results — has made them unpopular with investors who have turned to value stocks as the US Federal Reserve has stepped up its fight to curb inflation.
“While the benefits of equity compensation are clear, they increase the company’s risk profile, adding stress to a down market,” Mr Palfrey wrote in a research note.
Companies use stock-based pay to attract and retain talent by offering the potential for huge price increases when new companies reach their profitability.
Those types of companies — like DocuSign, ServiceNow and Etsy — have been market darlings in the boom that followed the Covid-19 pandemic, as investors piled into up-and-coming names that benefited from the lockdowns. .
With inflation at its highest in four decades, high valuations and bets on future growth no longer look reasonable as the Fed raises interest rates.
“Stock-based compensation is a popular tool for long-term pre-earnings, but public, technology companies to attract talent. So amid a rising interest rate environment, we’re clearly seeing the end of the high performance of large adopters of stock-based compensation,” said Art Hogan, chief market strategist at B. Riley.
Notably, the decline in company performance in stock-based employee compensation spans most sectors of the S&P 500, from discretionary companies such as eBay to financial companies such as BlackRock and biotechnology firms such as Vertex Pharmaceuticals.
Mr Palfrey said this downward trend was likely to continue if the current market slump turned into a recession, but in the event of a soft landing – his base case – the trend should reverse.
Historically, these companies have outperformed by 1.8 percent over the past 17 years.
Meanwhile, the current underperformance of stock-based compensation companies is likely to weigh heavily on companies as they try to attract and retain workers.
Updated: July 22, 2022, 4:30 AM