What’s In SGA?

Walmart spends $116 billion on operating SG&A, the details of $8 billion of which could actually be found in its FY 2020 10K.  Why is no one asking what is in the rest? Especially, how much of SG&A creates an intangible asset?

The SEC has recently indicated its interest in getting firms to report more data on human capital management. I have written before about the importance of labor costs as a critical human capital metric. But I hadn’t appreciated how opaque Selling, General & Administrative expenses or SGA has become, especially considering it’s the leading line item in an income statement that contains most labor costs.

Consider the largest SG&A spender among U.S. companies with a market capitalization of more than $100 billion: Walmart. Walmart spends $116 billion on their “operating, selling, general and administrative expenses.” The note in its 10K describing this line item reads as follows.

Operating, Selling, General and Administrative Expenses

Operating, selling, general and administrative expenses include all operating costs of the Company, except cost of sales, as described above. As a result, the majority of the cost of warehousing and occupancy for the Walmart U.S. and Walmart International segments' distribution facilities is included in operating, selling, general and administrative expenses. Because the Company only includes a portion of the cost of its Walmart U.S. and Walmart International segments' distribution facilities in cost of sales, its gross profit and gross profit as a percentage of net sales may not be comparable to those of other retailers that may include all costs related to their distribution facilities in cost of sales and in the calculation of gross profit.

Some more digging suggests that of the $116 billion, advertising accounts for $3.2 billion. Operating leases account for $2.6 billion, stock option expenses for $1.1 billion, and around of $1 billion is attributable to impairment charges. Great. What about the other $108 billion? By and large, a reader of the 10-K doesn’t have much of a clue. 

Another example is Microsoft which reports $19.5 billion in sales and marketing and $5 billion in General and administrative expenses in its FY 2020 10K. Microsoft states that sales and marketing expenses include “payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade shows, seminars, and other programs.” Advertising costs are identified as $1.6 billion. 

Are we to conclude that most of the remaining $18 billion is spent on payroll for sales staff? Microsoft reports it that employs 40,000 employees in sales, so is all this compensation for the sales staff? How much of this is an expense incurred to earn this year’s revenue versus brand building investments that will fetch future revenue and potentially deserve to be treated as an asset on the balance sheet? How much of Microsoft’s revenue would suffer if half of these people were let go? We have no idea.

Why does this all this matter? As my co-author, Anup Srivastava reminds me, SG&A spending in fiscal year 2020 is larger than cost of goods sold (COGS) in many iconic American companies such as Microsoft, Facebook, Johnson & Johnson, Novartis, Cisco, Oracle, Salesforce and Uber. Simultaneously, there is growing concern that value stocks have underperformed glamor stocks where value is measured as market-to-book ratio. Because U.S. GAAP requires large companies to co-mingle outlays on intangible assets such as brand building and R&D with regular expenses incurred to earn this year’s revenue, book value of equity in the market to book ratio is understated. Researchers in academe and in practice, have tried correcting for such distortion by estimating, as best as they can, the portion of SG&A that actually creates assets. 

But I wonder whether researchers (myself included) have dived too deep into the mathematics of correcting for this distortion before fully understanding what is being measured or counted. What’s in SG&A? That’s hard to know as virtually very little is disclosed. 

Who can fix that? Only the SEC or the FASB although I suspect regulatory fixes will take a long time. So, what about the market for voluntary disclosure and corporate governance?  I have not seen many transcripts of conference calls where sell side analysts push companies to reveal more of what is their SG&A and R&D lines. Why are more questions not being asked about the specifics of a firm’s SG&A and its R&D?  In particular, how much of this is an expense, the benefits of which expire within a year, as opposed to capital expenditure that creates longer term value?