Cash On Balance Sheets Is Big Concern
Posted by Jason Apollo Voss on Jul 21, 2011 in Blog | 0 comments
U.S. corporations are amassing massive amounts of cash – I am guessing over $3 trillion – on their balance sheets and this is a big concern of mine. Why? Because these corporations are earning about what you and I earn on cash balances – between 0.25% and 2.0%.
In business school they teach you that businesses have several uses for cash:
- To pay down debt
- To pay dividends to shareholders
- To fund stock buybacks
- To fund new projects
Businesses are not by and large doing any of these three things. Let’s take these, not quite in turn.
They seem to be holding cash in case of a rainy, stormy economic day. If I were a business leader I would want to pay down my debt levels. Except businesses like the tax deduction that they receive for debt. So they aren’t paying down debt. The incremental return to businesses here would be greater than the 0.25-2.0% they are earning on their cash balances, probably in the range of 4-6% in terms of financing savings. But they aren’t doing this.
Normally businesses hate to pay out dividends to shareholders because they like to keep the cash to fund their own projects. But even more importantly, they hate to pay out dividends because they consider such payments to their owners to be not tax efficient; and they aren’t.
You see, dividends are paid out to corporations with after tax profits. But then the IRS turns around and taxes shareholders for the dividends that they are paid by the businesses that they own. So the monies are double taxed.
This just is not an efficient use of cash, or so the theory goes. While true theoretically, that cash, unless invested by the corporation in new projects or something like a stock buyback, earns a paltry 0.25%-2.0%.
In effect businesses are saying “shareholders are dumb” and we can earn a higher balance than they can. But really, is this true? I have a hard time believing that, even after tax, I couldn’t earn more than 0.25%-2.0%. Couldn’t you?
This brings us to the final two things on my list; things that businesses ought to be doing, but are not doing.
Again, in business schools they teach students, including future CEOs, that a business should always seek the highest and best use for their cash. Typically this means that businesses will invest in growth projects that increase revenues, or save expenses.
In the case of the massive cash balances on corporate balance sheet, the incremental revenue or expense saving project currently only needs to generate more than 2.0%. But businesses just don’t seem to have a higher and better use for their cash. Instead they are sitting on the cash earning very little money. And this very much concerns me.
This means that businesses seem to be on auto pilot. That is, they are racking up sales that they normally would make, selling old products to the same old customers. There don’t seem to be new products to entice old customers, and more importantly, new customers, to spend their monies. This folks, is, on a scale of 1 to 10 regarding investment concerns, about an 8 or 9.
Businesses just can’t seem to come up with any new ideas, and that is the bedrock of economic growth and of gross domestic product (GDP) growth. Yikes! Nor are businesses hiring new employees to relieve their overworked employees and reducing the haunting unemployment rate. Double yikes!
Lastly, it is often the case that businesses don’t have high return, incremental projects. In these situations businesses will frequently buy back their stock shares in the marketplace. And that is happening. By some accounts, as of the end of May, stock buybacks totaled $263 billion in the U.S.
While this may sound like a refutation of my point, it isn’t. Why?
First, stock buybacks for the same period last year were $164 billion. So the increase represents $99 billion of a U.S. corporate cash pile of almost $3 trillion. In other words, businesses are still only spending 3.3% of the amount of available cash!
Second, stock buybacks don’t drive long-term, permanent shareholder value. New ideas and innovation are what drives long-term shareholder value. And this is exactly what has me so concerned. Trust me, as you look across the globe it is difficult to identify any sector or country that is driving the next wave of economic growth. And this folks, is definitively not a good thing.
Jason
