A company can report one profit under GAAP accounting and a much larger number under “adjusted” earnings.
One common reason is stock-based compensation, or SBC.
Companies often give employees restricted stock units, options or other equity instead of paying all compensation in cash. Under U.S. accounting rules, that stock compensation is still recognized as an expense at fair value.
But many companies then add the expense back when reporting non-GAAP profit.
That does not mean the stock was free.
Why Companies Add SBC Back
Imagine a software company reports:
- Revenue: $1 billion
- Other operating costs: $700 million
- Stock-based compensation: $100 million
Under GAAP, operating profit would be roughly $200 million.
If management excludes the $100 million SBC expense, adjusted operating profit becomes $300 million.
Why make the adjustment?
The main argument is cash flow.
Issuing employees shares does not normally require the company to transfer $100 million of cash at the moment the accounting expense is recorded. Management may therefore argue that excluding SBC gives investors a clearer look at the underlying cash-generating business.
Companies frequently use similar reasoning when calculating adjusted EBITDA and adjusted EPS.
The SEC permits companies to report non-GAAP measures, but requires clear reconciliation with comparable GAAP figures and warns that adjustments can become misleading when they remove recurring costs necessary to operate the business.
Non-Cash Does Not Mean No Cost
This is where investors need to be careful.
Employees receiving shares are still being compensated with something valuable.
If those awards create additional shares, existing investors can experience share dilution.
Suppose a company earns $1 billion annually and has 100 million shares outstanding.
Its earnings per share are $10.
If employee stock awards eventually increase the share count to 110 million while profit stays unchanged, EPS falls to about $9.09.
Companies can offset that dilution by repurchasing shares, but those buybacks consume cash.
Alphabet offers a useful real-world example. The company recorded $27.1 billion of stock-based compensation in 2025, including $24.1 billion tied to awards expected to settle in stock.
Its recent buyback pause showed why investors watch SBC and repurchases together: when fewer shares are bought back, employee equity awards can have a greater effect on the share count.
GAAP and Adjusted Earnings Answer Different Questions
Neither number should automatically be dismissed.
GAAP earnings ask:
After recognizing all required accounting expenses, how profitable was the company?
Adjusted earnings usually try to answer:
How profitable was the underlying operation if certain expenses are removed?
The problem comes when stock compensation is large and persistent.
SBC is often recurring at technology companies. Removing it every quarter can make adjusted margins look considerably better than the economics shareholders actually experience.
The SEC has specifically warned that excluding recurring operating expenses can make non-GAAP measures misleading.
That is why investors should compare adjusted earnings with GAAP results rather than choosing only one.
| Metric | Includes SBC? | What it shows |
|---|---|---|
| GAAP earnings | Yes | Accounting profit after stock compensation |
| Adjusted earnings | Often no | Management's view of underlying profitability |
| Free cash flow | SBC not a current cash outflow | Cash generated after operating and capital spending |
| Diluted EPS | Reflects potential shares | Profit available per share |
A company can therefore produce strong free cash flow while simultaneously issuing large amounts of employee stock.
Those two facts are not contradictory.
What Investors Should Watch
Three numbers usually matter most:
Stock-based compensation as a percentage of revenue. A rising percentage means equity compensation is consuming a larger share of the business economically.
Diluted share count. If it keeps rising, shareholders are being diluted despite strong adjusted earnings.
Buybacks versus stock issuance. A company may announce billions of dollars in repurchases while much of that spending merely offsets employee compensation.
That is why a large buyback is not always the same as a large capital return. Samsung, for example, recently approved a major employee buyback, highlighting how repurchases can serve different purposes.
The simplest rule is this:
Stock-based compensation may be non-cash today, but it is not economically free.
Adjusted earnings can be useful, especially for comparing operating trends. But if SBC is excluded, investors should still check how many new shares are being created and how much cash the company must spend to offset them.
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