January 29, 2012 7:40 pm
Hordes of hoarders
Companies’ growing cash piles are irking shareholders and stunting growth
Call it the $1,700bn problem. Companies in the US are flush with cash and are paying out a smaller proportion of their earnings as dividends than ever before. Much the same can be said for western Europe. Governments and households on both sides of the Atlantic are meanwhile strapped for cash. This cannot persist much longer.
The implications for politicians, the financial services industry and the economy as a whole are profound. Money paid to investors does not go to acquisitions or new investments; businesses run “for cash”, rather than spending in an attempt to boost revenues, do not promote growth. “Politicians and policymakers are going to have to ask the question – how much longer are we going to allow companies to run themselves for cash?” says David Bowers of Absolute Strategy Research in London.
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At present, cash accounts for more than 6 per cent of the assets on the balance sheets of US non-financial companies. That is the highest in at least six decades, and represents the fruit of record high profit margins. Companies cut costs through redundancies during the post-Lehman economic swoon, while negligible interest rates reduced their borrowing costs. As a result, US corporate profits are higher, as a share of gross domestic product, than at any time since 1950.
But as uncertainty persists, groups are reluctant to repay that cash to shareholders by buying back stock or – particularly – paying dividends. The pay-out ratio (the proportion of earnings that go in dividends) for the S&P 500 index is at its lowest since 1900.
Why? For years, investors have not pushed the issue. Academic theory says they should not care whether cash is paid out or left on the balance sheet. Either way, it belongs to them. “There was a time in the 90s when dividend was a four-letter word,” says Jim Cullen, a Boston fund manager. “They were for old ladies.”
James Henderson, a fund manager for Lowland Investment Company, a UK investment trust, puts it another way. “Companies held back on dividends to make themselves look more like growth stocks,” he says. Then came what he depicts as “a return to the roots of equity investing, which was that you put your money into a venture and then you harvested your return – and that return didn’t depend on whether the price of the asset had gone up recently”.
Now, companies that disappoint dividend expectations are punished. Not even Apple, the world’s largest company by market value, is immune. Despite reporting phenomenal profits this month, its price-earnings multiple remains about 10 per cent below that of the S&P 500. Some attribute this to Apple’s cash pile of almost $100bn – enough to buy Dell, its erstwhile conqueror, three times over. It has never yet paid a dividend. During Apple’s conference call, investors asked insistently about the chances that – like Microsoft before it – Apple would start disgorging its cash as dividends.
Investors’ push for higher cash pay-outs is affecting market performance. Last year, the S&P 500 was flat; but the 10 per cent of stocks with the highest dividend yield enjoyed an average gain of 18 per cent, according to Savita Subramanian of BofA Merrill Lynch. Demographic trends drive this. Ms Subramanian describes it as a secular imbalance of demand and supply. On the demand side, the west’s population is ageing fast and needs income in retirement.
Fund managers are marketing dividend funds hard. “Equity income is the only mutual fund asset class left standing in the UK,” says Neil Dwane at Allianz Global Investors, which launched a new dividend fund in 2009.
Demand is also driven by low yields on bonds – pension funds have to consider equities instead – and by falling appetite for risk after two market crashes in a decade. For more than 50 years, US stocks had a lower cash yield than bonds did. That has now shifted. Where once the philosophy was that bonds should pay a higher yield because stock prices could go up, now investors demand a higher yield from stocks, because their prices can go down.
Dividend demand also betrays a crisis of trust. Robert Schwob of Style Research in London calls this a “batten down the hatches” attitude. “It’s an expression of fear. It’s saying ‘give it to me now, I cannot wait’.”
Unlike earnings, which are subject to accounting tricks, a dividend cheque is solid. And investors no longer trust managements to invest surplus cash wisely, preferring “dividend discipline”. Andrew Lapthorne of Société Générale drew laughter at a London conference this month with a series of “examples of how zero yielders use your money”. For example, Google, a non-payer, plans to develop a “space elevator”.
Faced with such investor demands, companies may opt to maintain fat margins and pay more of their profits out in dividends. Their reward would be cheaper equity capital (through a higher share price).
Managing “for cash” makes sense if the economy grows slowly, as it is hard for revenues to grow. But while this might keep investors happy, governments would feel differently. Politicians want companies to grow, to create jobs and to generate the tax revenues needed to plug their deficits.
“We are seeing a symbiotic relationship between government ‘borrowing’ and corporate ‘saving’ the likes of which has rarely been seen before,” says Ian Harnett of Absolute Strategy.
Governments could yet respond by raising corporate taxes, tweaking them to encourage spending, or increasing dividend taxes. But it will be hard to cut public deficits without some aid from corporate cash, which investors want paid to them. Neither option – a heavily taxed corporate sector or one that pays out cash rather than reinvesting it – is conducive to capitalism at its most vibrant.
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