Stock rout hits employers who offer equity compensation to workers

Investors have turned to value stocks as the US Federal Reserve stepped up its battle to curtail inflation. Getty

The promise of rapid profit growth that entices some companies to pay staff with stock grants or options has turned into a predictor of share-price underperformance during the 2022 rout.

Companies that have outsize stock-based compensation programmes have trailed the broader market by 9.2 per cent so far this year, Patrick Palfrey, a senior equity strategist at Credit Suisse, found.

The profile of such companies — primarily tech and other newly public entities expected to deliver above-average earnings gains — has left them out of favour with investors who turned to value stocks as the US Federal Reserve stepped up its battle to curtail inflation.

“While the benefits of equity compensation are clear, they do increase a company’s risk profile, adding stress in a down market,” Mr Palfrey wrote in a research note.

Companies use stock-based pay to lure and keep talent by offering the potential for massive price gains once fledgling companies hit their earnings stride.

Those types of companies — such as DocuSign, ServiceNow and Etsy — were market darlings in the surge that followed the Covid-19 pandemic, as investors piled into up-and-coming names that benefitted from lockdowns.

With inflation running at the highest in four decades, lofty valuations and bets on future growth no longer look justified as the Fed raises interest rates.

“Stock-based compensation is a popular tool for long-duration technology companies that are pre-earnings, but are public, to attract talent. So amid a rising interest-rate environment, we are clearly going to see the end of high performance of the big stock-based compensation users,” Art Hogan, chief market strategist at B. Riley, said.

Notably, the dip in stock-based employee compensation company performance spans across most S&P 500 sectors, ranging 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 persist 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 per cent over the past 17 years.

Meanwhile, the current underperformance of stock-based compensation companies is likely to weigh on companies as they try to attract and retain workers.