In the aftermath of the global financial crisis, large corporations have become hoarders of cash, says Aberdeen Asset Management’s Bruce Stout.
Historically, hoarding has been an activity with a diverse following.
The practice brings to mind those with a penchant for stuffing their abodes with old newspapers and cats; pirates with hidden piles of gleaming doubloons; and those with a sense of foreboding, who stockpile tinned food and candles as insurance against some future catastrophe.
In the aftermath of the financial crisis, however, some new members joined this miserly band – large corporations.
Insecurity and uncertainty left companies unwilling to commit to any significant spending.
Events served to remind us that cash was king – when bank finance dried up and the debt markets closed, those companies burdened by vast debt were as good as dead.
So in the years afterwards, instead of spending freely on growth and investment, they chose to squirrel away revenues.
According to the Federal Reserve’s Financial Accounts of the United States report, small businesses and non-financial companies had deposits worth $2.6 trillion at the end of 2014.
Some of the largest US multinationals have displayed a preference for doing this overseas. A recent study of the securities filings of 304 such companies showed that they have more than $2 trillion worth of profits salted away in other countries.
To date, this process has proven to be an effective accounting system for the companies – they bypass US corporations tax at a rate of 35 per cent while the profits stay abroad, instead of being subject to (usually more lenient) foreign levies.
Some commentators have suggested that a “tax holiday” with an extremely low rate of corporations tax would be the best way to encourage repatriation of these profits.
But President Obama is keen to recoup some of the disappearing duties for government spending on infrastructure.
Accordingly, his Budget for 2016 includes a proposal to impose a one-time levy of 14 per cent on relevant profits, whether or not they are brought back into the US.
The current strength of the dollar must also be a concern for these companies, with shareholders preferring businesses with a stronger domestic focus.
After all, a more powerful US currency weakens the value of profits earned in other denominations.
Taking from the (cash) rich
Meanwhile, other parties have also put pressure on companies to dust off their cash caches.
While central banks and monetary policy setters are keen for funds to re-enter circulation and help boost the economic recovery, activist investors have pushed for them to be redistributed among shareholders.
This latter philosophy is gaining traction – Goldman Sachs recently said that it expects US blue chips to return a record $1 trillion to shareholders during 2015.
While it’s certainly proving popular among shareholders, the long-term effects are uncertain. Where dividends have long been venerated by investors, share buybacks are a newer concept.
Last year, investors in US companies received $553 billion from share buybacks, compared to only $350 billion in dividends.
Not entirely coincidentally, this new-found popularity has coincided with the recent bull market for US stocks.
Between the end of 2008 and the beginning of 2015, the blue chip S&P 500 index gained almost 160 per cent in dollar, total return terms.
So companies are divesting some of their cash hoards, investors are reaping rewards and equity markets are being driven higher – at first glance, it’s difficult to identify any drawbacks to buybacks. But the practice raises questions for the long term.
Some cynics point to the immediate boost such a scheme provides to return on equity (ROE) and earnings per share (EPS).
With less outstanding equity, there will be an intuitive increase to ROE and EPS, presenting a desirable picture of the company to investors.
Yet the increase to these ratios is automatic – driven purely by the fact that fewer shares are in issue, rather than their being an improvement in earnings performance.
Perhaps the relative ease with which large companies can increase their appeal by carrying out a buyback lessens their motivation to improve earnings performance by the more traditional channel – generating growth.
This relates to another hazard of the buyback process – that it becomes a self-perpetuating cycle which stymies expansion.
As companies are habituated to the idea of using cash as a quick fix for shareholder morale, they become less willing to cut into operating margins in order to increase capital expenditure on their own projects, or to expand by method of merger or acquisition.
Ambition is replaced by apathy. Outside of the US, braver companies – including those in Asia and emerging markets – are using their access to credit and lack of a debt overhang to generate income growth.
This is an essential factor in generating long-term returns for shareholders.
As this pattern of amassing cash then executing share buybacks becomes more established, the companies responsible are looking less Long John Silver-esque and more like ill-advised Robin Hoods.
And given his plans to recoup lost taxes from some of the biggest hoarders, it’s tempting to cast President Obama as a Sheriff of Nottingham figure.
In this case, though, the threat of taxation could be a useful way to encourage management boards to think more carefully about what they plan to do with their cash piles.
The long-term interests of the “poor” (shareholders) are not necessarily best served by indiscriminate cash handouts (buybacks).
Bruce Stout is a senior investment manager within Aberdeen Asset Management’s global equities team.