Analysis: Corporate cash hoard screams "buy" for investors

Mon Jan 30, 2012 10:08am EST

Four thousand U.S. dollars are counted out by a banker counting currency at a bank in Westminster, Colorado November 3, 2009.  REUTERS/Rick Wilking

Four thousand U.S. dollars are counted out by a banker counting currency at a bank in Westminster, Colorado November 3, 2009.

Credit: Reuters/Rick Wilking

(Reuters) - Apple's blowout quarter this week increased its cash holdings to almost $100 billion, a staggering hoard that casts a spotlight on what may prove a big catalyst for the U.S. equity market in coming years.

U.S. corporations are sitting on record levels of cash - nearly $1 trillion for companies in the Standard & Poor's 500 index - but with the exception of high dividend-paying stocks this past quarter, that cash pile has done little to boost share prices.

Investors often shun companies with excess cash as they fear management will negotiate expensive or ill-advised acquisitions, or buy back shares when the stock is far from cheap.

But that notion may be short-lived. In coming years, a pile of cash is going to be a distinct advantage in what is likely to be a conservative borrowing environment. Those cash-rich companies are the best placed to outperform the market.

"In the coming decade, rather than U.S. companies being absorbers of capital we expect them to be sources of capital," said Richard Vigilante, director of selected research at hedge fund Whitebox Advisors in Minneapolis.

That's if they use the cash wisely.

Cash as a percentage of the S&P's market value is now at 11.48 percent, just shy of a record high reached in 2010. The $998.6 billion that the S&P 500 companies hold is up 63 percent from five years ago, and nearly double the $342.3 billion in cash they held a decade ago.

That cash figure for S&P companies excludes financials, transports and utilities, which keep high balances as part of normal operations.

Faced with low to negative yields their cash holdings now generate, companies will seek higher returns either through investing in themselves or other companies, Vigilante said.

"It's much more likely that start-up and innovative firms are going to get their capital by being bought out by major companies," he said.

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DEPLOYING CASH

Given the weak venture capital and private equity environment, tighter bank lending and a more cautious hedge fund industry, corporate America looms as a major supplier of cash.

However, with the exception of paying dividends, Wall Street generally fears management's use of excessive cash. And cash as tinder for higher prices, for example, has yet to catch on.

The top 25 members of the S&P 500 when ranked by the cash held as a percentage of market capitalization returned 2.92 percent last year, according to Birinyi Associates Inc of Westport, Connecticut. The bottom 25 returned 11.75 percent.

Deploying cash to deliver higher returns will become a hallmark of the great American company, marking a break with the past, when product innovation, growing market share and creating new markets were prized attributes, according to Whitebox.

Like other investors, Whitebox founder Andrew Redleaf has hailed quality, large-cap U.S. corporations for more than a year now. He also sees a decade where equities will double in price, and he believes the large caps will be the major beneficiary.

But there are hurdles. Corporations have a poor history of repurchasing shares at low prices, and there are any number of highly visible, poorly conceived or executed takeovers.

"Capital allocation is not a highly valued skill. What's highly valued is spending capital fast to grab onto the next innovative possibility," Vigilante said. "In a conservative era, which I think we're heading into, skillful capital allocation is going to become a differentiator of firms."

Companies repurchasing their debt and stock buybacks are also both at record levels, yet companies that engaged in those two activities saw their share prices underperform the market.

Over the past three years ended in early December, Wal-Mart Stores Inc cut its outstanding shares by 12.7 percent, prompting newsletter publisher Jim Grant to observe that at that rate there would be no more shares of Wal-Mart in 15 years.

Since the S&P 500 hit a 52-week low on October 4, the broad measure for U.S. equities has rallied nearly 24 percent, yet Wal-Mart's shares have lagged that run-up by more than 4 percentage points.

A study by Thomson Reuters suggests that most S&P companies have not successfully added value through stock repurchases over the past decade.

The study did identify firms with a history of strategically repurchasing shares at low prices, and more importantly, reducing buybacks when their stock rose, such as J.C. Penney and St. Jude Medical. Those actions were beneficial to stock owners as signals to buy or sell.

In the third quarter of 2011, stock repurchase activity among S&P 500 companies reached almost 4 percent of their market cap, levels unseen since before the financial crisis.

Thomson Reuters found surprisingly few companies were able to repurchase shares at lower prices and see price appreciation within the following 12 months. Some did the opposite, such as Netflix, which continued to buy as its stock soared and later had to issue shares for funding.

Whitebox is still developing models to screen for the companies that will prove successful wardens of their capital.

Another problem is that much of corporate America's cash is held overseas.

Apple reported $97.6 billion in cash and marketable securities, with about $64 billion of that held abroad. Management offered few clues about its plans for the cash, other than to hint it may invest in its supply chain or in acquisitions.

Companies that tried to grow internally through big research and development programs or large capital expenditures were both down about 6 percent in 2011, said Robert Turner, chairman and chief investment officer at Turner Investment Partners in Berwyn, Pennsylvania. Even cash deployed in takeover activity only earned about a 2 percent return, he said.

"In essence, if you used your balance sheet to try to grow revenues you got penalized last year. But if you paid it out in dividends the market rewarded your company," Turner said.

"I'd like to think as we move forward, companies might be given a little bit more credit for using this cash to make strategic acquisitions that make sense," he said.

(Reporting By Herbert Lash; Editing by Leslie Adler)

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