Such prudence gives corporations great flexibility. They can grow their businesses, reduce leverage, raise dividends – or all three.
Dividend increases have become popular. Microsoft’s recently announced dividend bonanza, estimated at $75bn, is one example of corporations’ greater shareholder friendliness. Since the tax reduction took effect in 2003, dividend pay-outs have risen by 20 per cent, reversing a 20-year decline.
To those who believe economic profit is the most reliable gauge of long-run economic performance, using excess cash to pay down debt may be more appealing than other shareholder-friendly policies. When low yielding cash is spent to retire high cost debt, a company’s return on invested capital may increase markedly. The positive effect of deleveraging on a company’s credit rating is often an added, and significant, benefit.
How are investors likely to view the most risky use of cash to fund a business’s expansion? Normally at this stage of an economic recovery, capital expenditures accelerate for this reason. However, actual capital expenditures have confounded expectations. A recent US Federal Reserve study found that companies have only added 0.3 per cent to their total productive capacity in the past year. In fact, many businesses are still preoccupied with reducing capacity added during the bubble.
Long-term investors may welcome the commitment to growth implied by a company’s rising capital expenditures. Growth via merger is excluded because the benefit to shareholders is not always apparent. Instead, we take a positive view of bold bets on organic growth by managements. If opportunities are compelling enough, then managements may have found better uses for cash than returning it to shareholders.
Perhaps such investment will signal an end to the tight correlation among economic sectors and the narrow trading ranges that have characterised the current stockmarket. Often, heightened corporate investment activity signals the beginning of a sustainable advance not only for the equity market but for the economy as well.
Hugh Neuburger, US equity portfolio manager, Credit Suisse Asset Management
