by With profitability at U.S. corporations touching historic highs, and corporate cash piles as large as they’ve ever been, one of the top tasks of executives these days is simply deciding how best to spend the money. Companies in the S&P 500 had an aggregate cash balance of .43 trillion in the second quarter of 2015, which tied a record set in the fourth quarter of 2014. So what should companies be doing with all that money? In a recent white paper, Credit Suisse Corporate Insights, the Head of HOLT Corporate Advisory, Rick Faery outlined the two broad alternatives. “Returners” share the wealth right away with shareholders through dividends and stock buybacks, while “reinvestors” pump money back into the business, through a combination of organic growth efforts (capital expenditures, research and development), and mergers and acquisitions. For the last 20 years, companies deployed an average of 60 percent of cash flows to capital investment (28 percent to capex/R&D, 32 percent to M&A), and 26 percent to shareholders (12 percent dividends, 14 percent buybacks). “[But] in recent years,” says Faery, “due in part to the pressures of noisy campaigns by activist investors, there has been a shift in capital allocation priorities, favoring share buybacks and dividends over capital investments and M&A.
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Ashley Kindergan considers the following as important: allocation, buybacks, capex, capital expenditures, cash balance, corporate cash, dividends, Investing, Investing: Features, M&A
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With profitability at U.S. corporations touching historic highs, and corporate cash piles as large as they’ve ever been, one of the top tasks of executives these days is simply deciding how best to spend the money. Companies in the S&P 500 had an aggregate cash balance of $1.43 trillion in the second quarter of 2015, which tied a record set in the fourth quarter of 2014.
So what should companies be doing with all that money? In a recent white paper, Credit Suisse Corporate Insights, the Head of HOLT Corporate Advisory, Rick Faery outlined the two broad alternatives. “Returners” share the wealth right away with shareholders through dividends and stock buybacks, while “reinvestors” pump money back into the business, through a combination of organic growth efforts (capital expenditures, research and development), and mergers and acquisitions.
For the last 20 years, companies deployed an average of 60 percent of cash flows to capital investment (28 percent to capex/R&D, 32 percent to M&A), and 26 percent to shareholders (12 percent dividends, 14 percent buybacks). “[But] in recent years,” says Faery, “due in part to the pressures of noisy campaigns by activist investors, there has been a shift in capital allocation priorities, favoring share buybacks and dividends over capital investments and M&A.” In 2014, capital investment dropped to 53 percent (27 percent organic growth, 26 percent M&A) and money returned to shareholders rose to 36 percent (21 percent buybacks, 15 percent dividends).
So how have the differing approaches panned out? Not surprisingly, the initial returns on capital are generally lower for reinvestors than returners, averaging 9 percent and 11 percent, respectively. But those who reinvest successfully show greater operating improvement over the long-term, with cash flow return on investment up 180 basis points over five years, versus just 150 basis points for cash returners.
Meanwhile, companies that reinvest show dramatically stronger sales growth over a five-year period than returners, 19 percent versus just 5 percent. Even reinvestors that underperformed their peers saw sales grow 16 percent a year, compared to just 4 percent for underperforming returners. But the market looks to the future, right? Well, companies that reinvest also tend to be much more effective in increasing market expectations about their future growth than those that returned cash to shareholders. And the market has persistently paid a premium for companies that offer compelling growth stories over those that don’t.
Finally, there’s the question of the corporate life cycle. For early-stage companies, profitable growth opportunities are abundant and should therefore be aggressively pursued. As businesses mature, however, and cash flows expand and investment opportunities diminish, the balance should shift toward returning excess cash to shareholders.