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Cash-flush companies turn to buybacks

Despite their ongoing struggle to get customers to buy their products and services, large US companies flush with cash are handing it out like candy to win investors' affections.

Corporations are setting records buying back their shares and increasing dividends to their shareholders. Both approaches are enriching people who own stocks, and analysts think the trend will attract investors and continue to lift the stock market in 2014.

But the trend isn't necessarily as healthy for the economy.

Individuals like to pocket the cash from dividends, and they get more value from each share of stock they hold if companies decrease the number of shares available in the market. Theoretically, individuals feel wealthier when they are making money in the stock market, and that's supposed to help the economy because affluent people go shopping and make other large purchases.

Yet, while the Standard & Poor's 500 index has climbed about 25 per cent this year, the wealth effect hasn't cured a seven per cent unemployment rate. And companies haven't been willing to spend their cash on what the economy needs most - large purchases of equipment, construction of plants, and hiring of new employees.

Instead, they amassed cash, apparently still afraid to spend six years after the financial crisis. But with a collective $US1.25 trillion ($A1.42 trillion) sitting idle in the third quarter, companies are bending to pressure from large activist investors such as hedge funds, which are demanding: "Give me that money," said Howard Silverblatt, a senior Standard & Poor's analyst.

In the third quarter, 377 large companies of the S&P 500 devoted more the $US200 billion to dividends and buybacks - the largest amount since the last quarter of 2007, Silverblatt said. Dividends have reached a high of $US310 billion this year, compared with $US286 billion last year.

When Silverblatt tabulates results for the S&P 500, he leaves out financial companies and utilities because they are regulated and must hold certain reserves of cash.

While investors tend to get eager about buying stocks when dividends and buybacks are increasing their value, Silverblatt has reservations.

"People should be asking why companies have enormous amounts of cash and aren't spending it," he said.

The cash hoards have been building for 93 consecutive weeks, said Silverblatt, and earnings reports by companies have hinted at why: Companies have been able to generate record profits, but profits can be generated through cost-cutting and a tight workforce.

Selling more products and services is how companies ultimately grow successfully, and that's where companies say they are still struggling in a weak global economy.

Companies won't hire or invest in major projects "to make 115 widgets if they think they can only sell 110," said Silverblatt. They also don't like to promise dividends and change their mind later. If investors buy a stock expecting a certain dividend and find out later it is being reduced, investors sell the disappointing stock and buy another instead, said Rob Leiphart of Birinyi Associates.

So, buybacks give companies the most flexibility. Once a company starts buying back shares, it can halt the process if conditions don't look favourable later.

Buybacks increase the value of a stock. Think of it like a pie. Would you rather be among 12 people or eight people dividing up a single pie?

That applies to company profits too. People with shares of stock are entitled to a portion of the profits, and if fewer shares are in people's hands, people holding each share, basically, get a larger portion even if the company doesn't grow much.

Executives also can increase their compensation after a buyback if their rewards are tied to the company growing earnings per share.

This year, companies have announced $US741.5 billion in buybacks compared with $US477 billion last year, Leiphart said. The largest year for buybacks came just before the financial crisis, as companies announced $US863 billion in 2007.

Buybacks are becoming more expensive for companies as stock prices rise. Silverblatt notes that companies are paying 25 per cent more this year to buy back their shares than last year. Currently, low interest rates allow companies to borrow money cheaply and buy back shares. Yet with rates going up, buybacks might end up costing more.

This year's results are skewed by some very large buybacks, including $US40 billion for Microsoft and $US50 billion for Apple. Given the pressure to please shareholders, companies may authorise buybacks even when they are disappointing investors with earnings and laying off employees.

Cisco is a recent example, announcing a $US15 billion buyback and 4,000 layoffs.

Even companies seeking aid from taxpayers may reward shareholders with large share buybacks and dividend increases. In Illinois, Boeing and Archer Daniels Midland recently announced buybacks and dividend rewards for investors. Boeing surprised investors by boosting its dividend 51 per cent. The average for S&P 500 companies is 36 per cent.

Boeing announced plans to buy back $US10 billion in stock while the company is having states compete with everything from tax cuts to infrastructure development to lure its 777X airliner facility.

Of course, it's legitimate, with states competing with each other on proposals that are aimed at attracting jobs and building local economies. Meanwhile, Boeing and other companies are competing with buybacks and dividends to attract and keep shareholders.