Time to Put Corporate Cash to Work
By SAMUEL RO,
Posted: October 11, 2010
Anyone with a savings account knows that sitting on cash pays next to nothing. With the Federal Reserve’s target interest rate at 0 percent to 0.25 percent since December 2008, rates on most debt are at record lows. The 30-year fixed rate mortgage recently fell to a record low of 4.27 percent. The rate on money market accounts rate is just 0.69 percent. The 10-year Treasury note yields 2.41 percent.
Corporations face the same issue with the $1.8 trillion of cash idling on their balance sheets. But unlike individuals, corporations need to satisfy investors and large cash balances with little to no return put a drag on a company’s return on assets. Even though corporations will most likely maintain higher cash levels than before the credit crisis, CFOs are facing increasing pressure from shareholders to deploy at least some of this cash. They should do so and do it soon to help boost the economy.
The most obvious use of cash is to finance what’s known as organic growth. For example, a company could expand its manufacturing capacity or open new stores. This often leads to job creation. However, as long as the economy remains anemic, so will budgets for organic growth projects.
Mergers and acquisitions are another way for a company to grow. This has been a particularly attractive option because low borrowing rates allow corporations to cheaply pursue takeover targets. Unfortunately, M&A generally comes with layoffs to eliminate redundancies, although resulting cost synergies could lead to lower prices for goods and higher profits.
Starting to pay or increasing dividends has become a popular move. Of some 7,000 companies reporting dividend activity to Standard & Poor’s, 1,033 raised their payouts in the first nine months of 2010. During the same period in 2009, only 707 increased their dividends.
Stock buybacks have a similar effect on stock prices, pushing them higher. Buybacks increase earnings per share by reducing the number of shares outstanding, and imply that the stock being bought back is cheap. In the first half of 2010, S&P 500 companies bought back $132.9 billion in stock, up from $55.0 billion during the same period in 2009.
Mergers and acquisitions, dividends, and buybacks move cash from corporations directly to stockholders who can spend it, helping the economic recovery. Even if they reinvest the cash in other stocks, the buying activity boosts stock prices. This could increase household net worth and boost confidence.
How a company decides to unleash its cash depends on company-specific priorities. Still, it is increasingly apparent that investors are dissatisfied with companies just sitting on excess cash. If this was the intention of the Fed and its easy money policy, the plan seems to be working slowly but surely.
Warren Buffett famously said he would leave his children enough money to do anything, but not enough to do nothing. In the same vein, during these weak economic times, the Fed should keep rates low enough so companies can do anything, and so low that they must do something.
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