With Cash Piling Up, What Should Companies Do?
Many investors are getting impatient. They’re tired of watching as cash piles up on the balance sheets of many huge companies. It brings back the great debate as to what companies should do with this if there aren’t growth opportunities to invest in. Should they issue Dividends or initiate a Stock Buyback?
According to Douglas J. Skinner of the University of Chicago GSB,
Stock buybacks are now being used as substitutes for dividends, even by companies that continue to make payouts. The reason for that appears to be the increased volatility of earnings.
In some ways, says Skinner, repurchases are the superior choice for the issuer because "there’s total flexibility with stock repurchases, whereas you’re committed forever with a dividend." For obvious reasons, companies want to avoid cutting or omitting their payouts. “With repurchases, you could pay out $3 billion…one period and zero the next.”
So while corporations that have been paying dividends for decades continue to do so, their dividend policies are becoming more conservative, and they’re more frequently rewarding investors with buybacks. “If a firm has unusually high earnings one year, they’re not going to increase dividends; instead, they make a large stock repurchase,” declares Skinner.
It sounds like a reasonable approach for companies that have cash piling up and it also takes into account tax considerations.
We’re fans of stock buybacks as they generally deliver increased value for shareholders. In particular, any share-related related metric, like Price to Earnings, Return on Equity, Earnings Per Share and others, improves because of the reduced number of shares. Thereby, increasing the attractiveness of the security.
Additionally, stock buybacks are often a signal to the market that management feel their stock has been discounted too steeply.
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