It’s possible Congress has agreed on a stimulus program by now, with hundreds of billions if not trillions of dollars allocated to Corporate America. People are frustrated at the idea that businesses that purchased their own shares will now receive bailout bucks. But for some of those firms, that ignores a basic question. What did you want them to do with the cash? And it brings up the next question of, “What will they do with extra funds in the future?”
Over the last two years, U.S. companies bought more than $2 trillion of their own stock through buyback programs. David Rosenberg estimates that, since the Great Financial Crisis, companies have purchased $4 trillion of their own stock. If they hadn’t, they’d either have more cash to use as a cushion during the coronavirus pandemic, or they’d have less debt on their books, depending on whether they used earnings or borrowed money to buy back the shares. They might have increased dividends along the way, or even invested more in their business.
Companies that borrowed money to repurchase shares are easy targets. They look like they were taking advantage of low interest rates to goose their share prices, which often benefited executives who were compensated with stock options.
But what about the companies that used cash?
U.S. GDP growth bounced around 2% for the last decade, and appeared to be putting in another year of non-stellar growth before the virus infected everything. Inflation remained well below the Fed’s target of 2% for most of the decade as well, showing that we weren’t in danger of too many dollars chasing too few goods. It’s possible that companies were earning decent returns but didn’t see much reason to invest in plants and equipment. If they pay dividends, then shareholders must pay taxes, and investors then expect consistent dividends and punish companies that fall short.
Stock buybacks aren’t the only thing a company can do with cash, but it can be a prudent thing.
The current draft of the stimulus plan bans companies that receive bailout funds from buying back their shares while they have bailout loans outstanding. Senator Elizabeth Warren wants to ban stock buybacks forever.
However, that fight ends up, it’s clear that many firms will avoid the practice for the rest of this year, and will use it more sparingly in the future.
What will they do with the cash?
When America goes back to work, and more importantly is allowed to spend money in retail locations and travel, corporate revenue will bounce back. There will be an adjustment period during which companies deal with normalizing their income and expenses, but there’s no reason to think that business won’t be back to “usual” in a matter of months. After they pay off any bailout loans, then what do we want them to do with their cash?
Dividends have the hair of taxes and expectations, expansion for expansion’s sake makes no sense. We’ll demand that they build cash cushions, preparing for “the next time,” which will bloat corporate coffers and be used to purchase U.S. Treasuries, further holding down interest rates. Then what? Perhaps in lieu of regular dividends companies will declare special, one-off dividends each year, hoping to avoid payout expectations. Or we might see increased M&A activity, which would serve to further shrink the available pool of companies we can invest in. None of those options sound like great alternatives.
It’s likely that we’ll see some combination of the above. Firms will repay their bailout loans, then they’ll rebuild their balance sheets with large cash cushions, which could take a while. After that, we’re probably looking at special dividends followed by modest stock repurchase programs by only the strongest companies. Think Apple.
The retrenchment will lay bare how much stock companies are giving to executives, a fact often hidden by stock buyback programs, but it will also take some of the consistent wind out of the sails of the markets. That was a force that assisted all investors over the last decade.