Company Cash

A lot has been written and spoken about the huge cash build-up on company balance sheets.  To be sure the S&P500 companies had over $700 billion on their balance sheets and over $1.2 trillion in working capital at the end of 2010.  This is up significantly over the December 2007 numbers when they held $500 billion in cash and had working capital of $900 billion.  To say that they are flush with cash is an understatement.  So why are they not investing this money and creating jobs?  Shouldn't the economy be roaring forward and if not isn't it just a matter of when and not if the economy will recover?

To understand the mindset of the Chief Executives of the world we need to place ourselves in their shoes.  The first concern that they have is trying to get sales higher.  Who is going to buy their products when a large portion of the economy is still unemployed?  Second is to improve profitability.  This can be done through cost cutting and lay-offs.  To hire right now is a tough sell to the board who see the state of the economy and are holding all powder dry until the right opportunity.  Third, and to some CEOs, most important of all is to keep the stock price going up.  As a large swath of their incentive is linked to the performance of the stock price they are incentivized to do everything in their power to drive the stock price higher.  This presents them with the dilemma of growth versus austerity.

So what presents the right opportunity?  Well you can buy back your own stock if you think it cheap, you can increase the dividend or you can acquire other companies.  In this way you can grow your company and increase your stock earnings without hiring a person.  In fact through the acquisition process you can actually lay people off!  All of these uses of cash have been performed.  As an example preferred share dividends have increase from $2 billion in 2007 to $20 billion in 2010.  The result is a distribution to those that already have rather than to those that have no job.  Economic theory says that at some point this wealth is redistributed as the rich spend their money and this creates jobs but as we have already seen, inflation always benefits the few at the expense of the many.

Now don't get me wrong, I am no socialist, but using this study it is easy to see why the CEOs of the world are hoarding.  Until they see the light at the end of the tunnel they will continue to hoard.  There are glimmers of hope appearing on the macro economic landscape, but there are still too many clouds.  For example productivity is up while unemployment is still high.  While productivity will lead to greater profits at some point you need people to purchase your wares.

Furthermore, oil just past $100 a barrel and all the costs of raw materials are increasing.  Food and gas prices are soaring as are the costs of education and medical expenses.  The consumer is strapped and unemployed and we have inflation starting to rear its ugly head.  The outlook is not favorable to spend money on new hires or expansion.  As large companies with cash are able to withstand the turmoil far more easily than their small cap brethren this is reflected in the stock prices.  While I expect this to reverse at some point in time it appears to me that this will take some time.

Until the Federal Reserve sees a significant improvement in the economy they will continue to print money.  This will continue to stoke the fires of inflation and will continue to crowd the private sector out of the market.  Companies will continue to hoard cash and we will continue to head down the path of stagflation.  As the headline in Bloomberg magazine stated this week; " Would you invest in a company that lost $2 trillion last year and has a net worth of negative $44 trillion?"   Given this scenario the hoarding will continue.

If inflation becomes too high the fireworks will begin, but until that time large cap stocks should continue to perform well.