Do Dwindling Cash Transactions Signal Dearth of New Ideas, Fear of Future?

Has our belief in the infallibility of data caused us to insist on certainty rather than risk - to the detriment of innovation? JL

John Authers reports in the Financial Times:

Critics’ picture of tired ex-growth companies, out of ideas for growth, and deciding to reward their shareholders to the detriment of the chance for economic growth, has something to recommend it even if financial engineering has brought the US stock market close to its all-time highs for now that many public companies are choosing to pay out cash rather than reinvest it
Cash transactions are a moment of truth for companies. The amount they receive through sales, and how they deploy it, is clearly defined in their statements. Accounting standards allow them to make adjustments but the amount of cash they raise, and the way they choose to use it, remain truth-tellers.

For the third quarter of this year, it is now growing clear, large US-based multinationals have had to put up with far weaker revenues than they would have liked. Even if the numbers are not quite as bad as they look at first glance, this inescapably implies an underlying lack of vigour in the world economy. And yet the damage to US companies’ reported profits has been far more limited. That in turn can be attributed to US companies’ choices over their use of cash — which in the long run could exacerbate further their problems with weak sales.The latest tally by Thomson Reuters of earnings by the S&P 500 in the US finds that earnings are on course to fall 1.3 per cent on the back of revenues down 3.6 per cent. The former is better than expected, which helps to explain the explosive stock market rally of the past month, but the revenue number is well down to dismal expectations.

Much of this has to do with the strong dollar, which shrinks US multinationals’ overseas earnings, but not all of it. In Europe, Stoxx 600 companies are on course to report a drop of 8.2 per cent in revenues compared with a year ago — even though a weakening euro over that period should flatter multinationals’ overseas profits. (They also face earnings falls of 4.3 per cent year on year).

A second obvious factor is the collapse in the price of oil and industrial metals over the past year. This directly attacks the revenues of mining and energy groups. Indeed energy and materials groups have suffered savage falls in sales, of 35.7 per cent and 11.9 per cent respectively since last year. But US industrial companies have also seen sales fall 6 per cent while apparently far healthier sectors have seen only anaemic sales growth. The US information technology sector, which currently is leading stock market gains, has increased revenues by only 1.9 per cent over the past year.
So less cash is being funnelled into large US corporations, and their profits have ceased growing. However, their profitability, as measured by the Credit Suisse Holt group in a new white paper, shows a 13.5 per cent return on investment once excess cash is excluded. That excess pool of cash is enormous — $2.1tn, or 15 per cent of total assets.

That cash can be deployed in mergers and acquisitions, or reinvested in the business, or distributed to shareholders via dividends or by purchasing stock so as to shrink the outstanding float of shares.
Historically, according to the Holt white paper, companies have deployed an average of 60 per cent of their cash flows in capital investment (whether organically or through M&A) and have returned 26 per cent to shareholders (12 per cent dividends and 14 per cent share buybacks). More recently, the capital invested has dropped to 53 per cent while cash returned to shareholders has increased to 36 per cent, with an increasing share going to buybacks.
For the past seven quarters, according to S&P, at least 20 per cent of S&P 500 companies have reduced their share count by 4 per cent or more. That has risen to 23 per cent in the latest quarter.

60%Historically, according to the Holt white paper, companies have deployed an average of this percentage of their cash flows in capital investment

Buybacks that shrink the float of shares automatically increase earnings per share. Whether they are a good use of shareholders’ money depends on the intrinsic value of the company — if it is too cheap, then buying back stock is a great idea. If it is too expensive, investors would be better served by getting their cash in a dividend and then being free to invest it somewhere else.

But what of the fortunes of companies that pay out their cash, rather than those that reinvest? Paying out is a clear signal that a company considers itself to be “ex-growth” and cannot find good investment opportunities. It also tends to be a self-fulfilling prophecy.
The Holt paper follows the fortunes of “reinvestors” and cash “returners” and finds that the latter increase their sales by only 5 per cent per year over the ensuing five years on average. Reinvestors managed to grow sales at 19 per cent per year. So the critics’ picture of tired ex-growth companies, out of ideas for growth, and deciding to reward their shareholders to the detriment of the chance for economic growth, has at least something to recommend it.

it is still hard to read the pattern of cash flows optimistically, even if financial engineering has brought the US stock market close to its all-time highs for now

That so many public companies are choosing to pay out cash rather than reinvest it is therefore disquieting. There are some mitigating factors. Many large and fast-growing companies in the so-called “sharing economy” are booming, and are not public. The services sector in general, which is flourishing as the industrial sector suffers, includes many players outside the traditional structure of large public companies.
But it is still hard to read the pattern of cash flows optimistically, even if financial engineering has brought the US stock market close to its all-time highs for now. Companies are getting less cash than they used to, they are not optimistic that they can invest it productively and so they are choosing to deploy it in a way that weakens the chances of sales growth in the future. Not encouraging