The 3 Billion Dollar Question

What are they going to do with all that cash?

Over the past 3 years, corporations have built up quite a nest egg. Over $3 trillion in cash sits on corporate balance sheets, the fruit of years of rising margins and a formerly booming economy. When the downturn came, corporations cut costs to protect themselves. Now they have a cash war-chest. What are they going to do with that money?

Conventional wisdom says that firms do share buybacks with one-time cash bonanzas, they expand their business when the margins improve, and they increase their dividends when sales grow. Since the economy is still in the doldrums, and margins seem to be falling back to earth, share buybacks seem to be in the offing. But is this smart?

Share buybacks are supposed to decrease the cost of capital by increasing the percentage of tax-deductible debt in the capital base. But we’ve learned the hard way in the past two years that increased leverage means increased risk. And shares bought back in a rising market can be reissued when cash is scarce and markets are low, destroying value.

So what should companies do when cashflow is strong but investment opportunities are few? Well wow about giving shareholders the cash? If the company can’t put it to work, shareholders can. Either that, or find new managers.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-05T19:48:49+00:00 July 18th, 2010|Global Market Update|0 Comments

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