After a few very profitable years, many corporations have record amounts of cash on hand. Wouldn’t this be a nice problem? I have yet to experience this but feel I am up for the challenge. I always have an idea of what I could do with extra money...a cute pair of shoes, turn my bathroom into a Tuscan escape, or even set foot on Antarctica. I could go on for days. Publicly traded Corporations, on the other hand, have a much more limited list of what they can do with extra cash on the books. They can:
- Invest in their own securities through stock buyback programs
- Invest in capital, Research and Development, or hire more employees
- Acquire other companies
- Return the money to shareholders in the form of dividends
The first point is one I would like to dwell on. Generally, when stock buybacks are announced, investors assume that this will automatically add value to the stock price. This is logical, fewer shares outstanding means that the remaining shares own a larger slice of the company. However, this is not always the case. Often repurchased shares go right back out as part of compensation packages. Also companies don’t always complete share repurchase programs if they need to use the cash in another way.
The irony is companies are usually flush with cash after business has been booming for a couple years or longer and after their stock prices have already jumped substantially. This is when they tend to go on their shopping sprees. When prices are down, in the midst of a crisis like early 2009, companies usually hold on to any cash they may have left, fearfully, rather than taking advantage of short-term depressions in their stock prices.
David Zion an analyst and accountant for Credit Suisse came out with an excellent report on many stock buybacks over the past decade. It shows that corporations are just as prone to poor investment behavior with their cash as many investors (maybe even worse). Looking at one of the largest buyback programs over the eight years of the study, according to the Credit Suisse report, Hewlett Packard (HPQ) averaged an annualized loss of 11.3%!
Many experts are postulating that an increase in dividend taxes, which may occur next year, could lead to an increase in corporate stock buybacks (capital gains could be taxed at a much lower rate than dividends). Be very skeptical, though, since stock buybacks are no guarantee of generating capital gains!
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing materials are accurate or complete. Any opinions are those of Center for Financial Planning, Inc., and not necessarily of RJFS or Raymond James. Raymond James Financial Services, Inc., Its affiliates, officers, directors or branch offices may in the normal course of business have a position in securities mentioned in this report. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. As of 12/5/12 close, HPQ was trading at $13.82/share. HPQ is not closely followed by Raymond James Research.