What is dilution-aware valuation?

Dilution-aware valuation accounts for the impact of stock-based compensation (SBC) on shareholder value. Traditional models ignore SBC dilution, but Michael Burry's approach adjusts the valuation formula to reflect the true cost of equity dilution from stock grants and options.

What is Owner's Earnings?

Owner's Earnings is a cash flow metric that represents the true earnings available to shareholders. It's calculated as: Net Income + GAAP SBC (add back non-cash) - Actual Stock Buybacks - RSU Tax Withholding Payments. This shows the real cash cost of stock-based compensation.

How is this different from a regular DCF calculator?

Unlike traditional DCF calculators that use GAAP earnings or free cash flow, BurryDCF uses Owner's Earnings which properly accounts for stock-based compensation costs. It also applies a dilution adjustment to the Gordon Growth Model formula to reflect ongoing shareholder dilution.

Where does the data come from?

BurryDCF pulls data directly from SEC EDGAR XBRL filings (10-K and 10-Q reports) for Owner's Earnings components, and uses Polygon.io for real-time stock prices, dividends, and company information. All data sources are transparent and verifiable.

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Burry's Dilution-Aware DCF Guide

The complete guide to adjusting the Gordon Growth Model for stock-based compensation dilution

12 min read

Prerequisites

This article builds on concepts from our previous posts. If you haven't read them yet:

• CAPM Explained — Understanding the discount rate (d)
• Owner's Earnings — Calculating true cash flow (CF₁)

Contents

1. Traditional Gordon Growth Model

The foundation of perpetuity-based valuation

The Gordon Growth Model (GGM) is the classic formula for valuing a perpetually growing stream of cash flows. It's simple, elegant, and widely used — but it has a critical flaw.

Traditional GGM Formula

PV = CF₁ / (d − g)

Variables

PV = Present Value (fair value per share)
CF₁ = Next year's cash flow per share
d = Discount rate (from CAPM)
g = Perpetual growth rate

Key Constraint

d > g

The discount rate must exceed the growth rate, otherwise the formula produces negative or infinite values.

Example

A company with $5 per share cash flow, 10% discount rate, and 3% growth:

PV = $5 / (0.10 − 0.03) = $5 / 0.07 = $71.43

2. The Dilution Problem

Why traditional GGM overstates intrinsic value

The traditional GGM assumes your ownership percentage stays constant forever. But in reality, companies continuously issue new shares through stock-based compensation, diluting existing shareholders.

The Pie Analogy

Imagine you own 1% of a pie. The pie is growing at 5% per year (that's g). But the company is also giving away 2% of the pie to employees each year (that's y). Your slice is growing slower than you think — or even shrinking!

The Hidden Cost

When a company grants stock options or RSUs to employees, your slice of the pie gets smaller — even if the pie is growing. Traditional GGM completely ignores this, leading to systematically overstated valuations.

Traditional GGM Assumes

• Share count stays constant
• Your ownership % never changes
• All growth accrues to you

Reality

• Share count grows 1-5% annually
• Your ownership % shrinks
• Some growth goes to new shareholders

The Dilution Problem: A pie that is growing in total size (representing growth rate g), but with your specific slice being cut smaller (representing dilution rate y) — **The Dilution Problem:** Even if the company (the pie) grows at 5%, if they give away 2% of the pie to employees every year, your slice grows slower than you think.

3. Burry's Dilution-Aware Formula

Adjusting the GGM for ongoing shareholder dilution

Michael Burry's insight was to modify the GGM to account for perpetual dilution. When a company dilutes shareholders at rate y each year, the effective growth of per-share value is reduced.

Burry's Dilution-Aware Formula

PV = CF₁ / [(1+d)(1+y) − (1+g)]

Mathematical Derivation

The denominator can be expanded:

(1+d)(1+y) − (1+g) = 1 + d + y + dy − 1 − g = d + y + dy − g

For small values of d and y, the cross-term dy is negligible:

≈ d + y − g

This shows that dilution (y) effectively adds to the discount rate, reducing the present value.

Key Constraint

(1+d)(1+y) > (1+g)

The combined effect of discount rate and dilution must exceed growth. If growth is too high relative to d+y, the model doesn't converge.

4. Understanding Each Variable

CF₁ — Cash Flow (Owner's Earnings)

The expected cash flow per share next year. BurryDCF uses Owner's Earnings — the TRUE cash flow after accounting for the real cost of SBC.

CF₁ = (Net Income + SBC − Buybacks − RSU Tax) / Shares Outstanding

d — Discount Rate (CAPM)

The required rate of return, calculated using CAPM. Typically 8-15% for most stocks.

d = Risk-Free Rate + β × Market Risk Premium

y — Dilution Rate

The annual rate at which share count is growing (dilution) or shrinking (buybacks).

• Positive y: Dilution (shares increasing) — bad for shareholders
• Negative y: Net buybacks (shares decreasing) — good for shareholders
• Typical range: -5% to +5%

g — Growth Rate

The perpetual growth rate of cash flows. BurryDCF calculates this from historical Owner's Earnings growth (CAGR).

• Should not exceed long-term GDP growth (~2-3%) for mature companies
• High-growth companies may have higher g, but it will eventually decline
• BurryDCF caps g at 30% to prevent unrealistic valuations

5. Side-by-Side Comparison

Traditional GGM vs Burry's dilution-aware model

Let's compare both models using the same inputs to see the impact of dilution:

Inputs

• CF₁ = $5.00 per share (Owner's Earnings)
• d = 10% (discount rate from CAPM)
• g = 3% (perpetual growth rate)
• y = 2% (annual dilution rate)

Traditional GGM

PV = CF₁ / (d − g)

PV = $5 / (0.10 − 0.03)

PV = $5 / 0.07

PV = $71.43

Burry's Model

PV = CF₁ / [(1+d)(1+y) − (1+g)]

PV = $5 / [(1.10)(1.02) − 1.03]

PV = $5 / [1.122 − 1.03]

PV = $5 / 0.092

PV = $54.35

The Difference

The dilution-aware fair value ($54.35) is 24% lower than the traditional GGM value ($71.43). This is the "valuation haircut" caused by 2% annual dilution.

6. The Valuation Haircut

Quantifying the impact of dilution

The valuation haircut is the percentage difference between the traditional GGM fair value and Burry's dilution-aware fair value:

Haircut Formula

Haircut = (GGM − Burry) / GGM × 100%

0-10%

Minimal Impact

Low dilution or net buybacks — traditional GGM is reasonable

10-25%

Moderate Impact

Significant dilution — use Burry's model for better accuracy

25%+

Major Impact

Heavy dilution — traditional GGM is dangerously misleading

Negative Haircut?

If a company has net buybacks (negative y), the Burry model will produce a higher fair value than traditional GGM. This is correct — buybacks increase per-share value by reducing share count.

Valuation Haircut: Side-by-side bar chart comparing Traditional Fair Value ($71.43) vs Dilution-Adjusted Fair Value ($54.35), showing the 24% haircut gap — **The Valuation Haircut:** Ignoring dilution leads to systematically overstated valuations. A 2% annual dilution rate results in a 24% haircut to fair value.

7. When to Use This Model

The dilution-aware model is most valuable for companies with significant stock-based compensation programs:

Best For

• High-growth tech companies (NVDA, TSLA, META)
• Companies with heavy SBC programs
• Startups and growth stocks
• Any company with >1% annual dilution

Less Critical For

• Mature dividend-paying companies
• Companies with consistent buybacks
• Low-SBC industries (utilities, REITs)
• Companies with stable share counts

Pro Tip

BurryDCF calculates both models automatically and shows you the haircut. Even if you prefer traditional GGM, seeing the haircut helps you understand the dilution risk you're taking on.

Model Limitations

• Perpetuity assumption: Real companies don't grow forever at a constant rate
• Historical dilution: Past dilution may not predict future dilution
• Growth rate uncertainty: g is inherently difficult to estimate
• One input among many: Use alongside other valuation methods

Review the Foundations

Make sure you understand the inputs to this model

Discount Rate

CAPM Explained

Understand how to calculate the discount rate (d) using the Capital Asset Pricing Model.

← Read article

Cash Flow

Owner's Earnings

Learn how to calculate true cash flow (CF₁) using Michael Burry's methodology.

← Read article

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