I've been studying Michael Burry's writings on stock-based compensation and wanted to share some insights on how dilution affects intrinsic value calculations. This is something I don't see discussed enough in traditional DCF analysis.
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**The Traditional Gordon Growth Model**
Most of us are familiar with the perpetuity formula for valuing a stock:
PV = CF₁ / (d - g)
Where:
- CF₁ = Next year's cash flow per share
- d = Discount rate (required return)
- g = Perpetual growth rate
This model assumes your ownership percentage stays constant forever. But for many companies, especially in tech, this assumption is fundamentally flawed.
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**The Dilution Problem**
Companies like NVIDIA, Tesla, Meta, and Amazon issue significant stock-based compensation (SBC) to employees. While GAAP treats this as a "non-cash" expense, the economic reality is different:
1. New shares are issued to employees
2. Your ownership percentage decreases
3. Companies often buy back shares to offset dilution
4. Those buybacks represent real cash outflows
Burry's insight (from his Substack "Cassandra Unchained") is that the TRUE cost of SBC isn't the GAAP expense—it's the actual cash spent on buybacks plus RSU tax withholdings.
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**The Dilution-Aware Formula**
Burry proposes adding a dilution factor (y) to the valuation:
PV = CF₁ / [(1+d)(1+y) - (1+g)]
Where y = annual dilution rate (share count CAGR)
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**Worked Example**
Let's use simple numbers:
- CF₁ = $5.00 per share
- d = 10% (discount rate)
- g = 3% (growth rate)
- y = 2% (annual dilution)
**Traditional GGM:**
$5 / (0.10 - 0.03) = $71.43
**Dilution-Aware:**
$5 / [(1.10)(1.02) - 1.03]
$5 / [1.122 - 1.03]
$5 / 0.092 = $54.35
The difference: **$71.43 vs $54.35** — a 24% reduction in fair value.
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**Why This Matters**
For a company with:
- 10% discount rate
- 3% growth
- 2% dilution
The traditional model overstates value by ~24%. At higher dilution rates (some tech companies run 3-5% annually), the gap widens significantly.
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**Calculating "Owner's Earnings"**
Burry also suggests using "Owner's Earnings" instead of reported earnings:
Owner's Earnings = Net Income + GAAP SBC - Actual Buybacks - RSU Tax Withholdings
The RSU tax withholding piece is often overlooked—it's buried in the Financing Activities section of the cash flow statement. When employees vest RSUs, companies withhold shares and pay cash to the IRS on their behalf. This is a real cash outflow that reduces what's available to shareholders.
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**Practical Application**
When analyzing a company with significant SBC:
1. Calculate the historical dilution rate (shares outstanding CAGR over 3-5 years)
2. Adjust for stock splits (they cause false dilution readings)
3. Use the dilution-aware formula for your DCF
4. Compare to the traditional valuation to see the "haircut"
A haircut over 25% suggests the traditional model may be significantly overstating intrinsic value.
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**Discussion Questions**
I'd love to hear how others approach this:
1. **How do you currently account for dilution in your valuations?** Do you adjust the discount rate, reduce terminal value, or use a different method entirely?
2. **Do you think the market properly prices in SBC dilution for high-growth tech stocks?** Or is this an inefficiency that value investors can exploit?
3. **What's the highest dilution rate you've seen in a company you were analyzing?** I've seen some SaaS companies running 4-5% annually—at that level the haircut becomes massive.
4. **For those who've read Burry's Substack posts on this topic, what are your takeaways?** His NVIDIA analysis was eye-opening for me.
5. **Is there a dilution threshold where you just walk away from a stock?** Curious where others draw the line.
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**Sources:**
- Michael Burry, "Foundations: The Tragic Algebra of Stock-Based Compensation" (Cassandra Unchained Substack, Nov 2018, updated 2025)
- SEC EDGAR for shares outstanding data
- Company 10-K/10-Q filings for SBC and buyback data