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Stock Strategist

Are Options Hurting Your Stocks?

Stock-option issuance can weigh heavily on our fair value estimates.

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After much debate and delay, stock options will soon be treated as an expense on companies' financial statements--as they always should have been. Companies with fiscal years beginning after June 15, 2005, will be required to expense options in the first quarter of the next fiscal year, which means that companies that just started a new fiscal year on July 1 will be expensing options on income statements in fall. We will then find out whether moving this cost from footnotes to income statements will cause the financial Armageddon long prophesied by Silicon Valley.

My prediction: A Nasdaq meltdown is not at hand (at least, not one caused by expensing options), but we are in for several months of confusion as option-happy companies try to whitewash results by emphasizing pro forma earnings results that do not include options expense and complicit Wall Street analysts that follow the companies' lead. For investors who rely on price/earnings ratios as their main valuation tool, this might result in some uncomfortable moments. (Do I use the pro forma number? Do I increase my earnings multiple? Get me an aspirin!)

Pat Dorsey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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