Multiple stories recently have detailed how companies are sitting on cash surplus positions significantly larger than average. You can bet that there are a lot of discussions going on between company executives and their boards of directors about what to do with this pile of money. For most, the discussion comes down to five options:
They can buy back company stock.
This is an option that they have been very bad at lately. Company buy backs are supposed to be a strong signal that the company sees its stock price as being undervalued and they prefer investing in their own future revenue at the reasonable current price. According to an article in the May 10 Wall Street Journal, however, many more companies were buying back their stock in October 2007 when stock prices were high than were buying back in March 2009 when stock prices were at their low.
They can declare and pay a dividend.
This sometimes placates shareholders who prefer a total return story that includes income and stock price appreciation. Microsoft is a good example of a company that has had a huge cash position for quite awhile and now pays a dividend. The implication, though, is that there may not be better alternatives for putting cash to work.
They can buy something—like another company.
Although mergers and acquisitions (M&A) activity is up from last year, some Chief Financial Officers of companies are complaining that the costs to buy competitors has grown and bidding wars have begun as a result of too many dollars chasing after too few deals. If this happens too often, that can be the starting place for inflation.
They can make an investment in growth.
Many executives are reluctant to invest in research and development, more efficient systems, or a hiring spree, however, as they are unsure about the future and they don’t want to build new capacity if they don’t have to.
Finally, they can keep the money for a rainy day.
We think that most company leaders have outlooks similar to individual investors. They are keeping a much larger percentage of their assets in money market accounts because they are unsure about the performance of the global economy and the markets.
The default option seems to be No. 5, the most frequent choice when there’s no clear path or confidence in how to proceed. If companies continue to hoard cash, it could be a negative indicator for investment markets and the economy. If they start to spend cash, distributing it back into the economy via any of options one through four, it could be a positive for stocks in general.