Investors Want More…Investment

No, dummy.  We’re not going to talk about “investment” in the sense that everyone abuses the term – as in stock market “investing”.  We’re going to talk about real investment – spending, not consumed, for future production.   Anyone who’s read my primer on the monetary system knows that investment is one of the most important drivers of overall economic growth.  And while investment has been relatively robust over the last 5 years it is interesting to think about how much more robust this could be.  For instance, take these two charts.  The first is from Goldman Sachs showing how corporations are spending:

cash

Now look at what investors want companies to be doing with their spending:

Cash usage

 

Corporate balance sheets were never a big problem during the crisis (with the exception of banks and many non-bank financial firms).  But what’s interesting is that investors really want more capex and yet corporations seem to be involved in their usual pro-cyclical increases in dividends and buybacks.  It all makes one wonder – why aren’t corporations actually pouring more money into their own firms as opposed to just handing it back to shareholders?  My best guess is that it’s a lack of demand combined with the short-termism that has come to dominate corporate board rooms.  After all, buybacks are a great way to “make numbers” and boost short-term incentives without hurting the corporate income statement.

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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  • SS

    Exactly, companies know the easier way to boost EPS in the short-term is to buyback stock. Investing in something real means higher risk and potentially lower reward. Why boost EPS organically when you can boost it fictitiously?

  • Cowpoke

    You can thank uncle miltie (Friedman) for that.

  • pliu412

    Cullen,

    Z1 report shows Net corporate equity issues: -62.1(2009), -277.4(2010), -472.2(2011), -399.5(2012), -383.7(2013).

    As a consequence, the net worth shrinks dramatically in non-financial corporate business as below

    Seasonally adjusted change in net worth:
    -4499.6(2009), -385.4(2010), 803.1(2011), -262.8 71(2012), N/A(2013)

    Not Seasonally adjusted change in net worth:
    -2004.0(2009), 1474.0(2010), 932.4(2011), 1343.3(2012), 1973.5(2013)

  • Cowpoke

    plui412, where do you see that? I can’t find it:
    http://www.federalreserve.gov/releases/Z1/Current/z1.pdf
    Thanks

  • pliu412

    Cowpoke,

    PDF document page and line numbers are as follows.

    P117 Line 1 for not seasonally adjusted change in net worth
    P117 Line 10 for net corporate equity issues
    P132 Line 71 for seasonally adjusted change in net worth

  • Cowpoke

    OK, Thanks, And I just today saw an article about the financials being healthy above other instituitions which would have tied in good here. But I can;t find the article and I am getting tired..
    Perhaps manyana..
    Thanks pliu412 for pointing that out.

  • Odie

    Maybe another reason for the buybacks is that management compensation is more and more given out in stock options. They have therefore a personal interest in boosting the stock price.

  • jswede

    right – “lack of demand”, along with lack of ideas to stimulate demand, is why corporations are not pouring more money into their own firms…

    I can’t help but think of Apple. The first time they had an ungodly amount of cash, they created iTunes… the second time, they built an Apple Store empire…. this time? Jack up the dividend and announce a share buyback.

  • LVG

    Also don’t forget that more and more investment banks want companies to do stock repurchase programs because it’s a big source of revenues for them.

  • pliu412

    ***Borrow money for stock buybacks and dividends payout**

    Due to tax advantage and low interest rates, corporate business can use loans/bonds to pay dividends and buybacks.

    The Z1 report shows liabilities are significantly increased in non-financial corporate business as follows.

    Not seasonally adjusted liabilities:
    12904.6(2009), 13227.9(2010), 13879.6(2011), 14386.3(2012), 14960.9(2013)

    Seasonally adjusted liabilities:
    25416.8(2009), 27599.4(2010), 28380.5(2011), 30493.3(2012), N/A(2013)

  • John Daschbach

    Basic game theory probably has something to say about this. Given two competitive enterprises (with each other) in an environment where they are expecting slow growth and in our current very low real interest rate condition. Suppose Capex funding would allow either company to take a little market share from the other company, perhaps increasing profits. But in a low real interest rate environment, a company that spends it’s excess cash to fund Capex has no advantage against a company that can borrow are a zero real rate, invest in equivalent Capex, and restore the market share balance. If there is zero growth in the overall market for their goods, they both come out losers (they spent cash or borrowed money and ended up with no change in revenue). Nominally, all other things being equal, EPS has not changed, but cash has decreased or debt increased.

    However, if a company buys back shares with cash, EPS rises, all other things being equal. The other company is then compelled to buy back shares, which it can do with cash or debt at zero real interest rates. Revenue stays the same, but EPS rises for both companies.

    The real situation is more complex certainly, but I think in general this approach probably explains a good deal of the thinking behind the buy backs. But basically it’s smart people estimating the differential of EPS with respect to Capex spending vs differential EPS with respect to buy back spending. In a muddle through economy, it seems the latter is often estimated to be larger than the former, which makes sense from the simple picture above.

  • Stephen

    I agree.

  • S.E.

    Well put

  • Fed Up

    “My best guess is that it’s a lack of demand combined with the short-termism that has come to dominate corporate board rooms.”

    Cullen, do you think the most common definition of economics, unlimited wants/needs and limited resources, is true or false?

  • Jussi

    How should this be read with this one?

    “–It’s this flawed idea that businesses aren’t investing, aren’t hiring and aren’t contributing at all to the recovery. ” (http://pragcap.com/the-lack-of-business-investment-myth)

    In relative terms the above seems correct as the first chart here proves?

    Could one say that business indeed is not doing enough and owners are not getting their message (invest more) through?