This is an extension of some discussions I’ve been having and some blogs I had recently written on inflation and bonds. Because as you think about inflation and investment returns, you inevitably come to a point where the discussion turns to the cash on corporate balance sheets. I was going to put up some charts based on the Federal Reserve’s Flow of Funds data but thanks to Google, the Trader’s Narrative and the good folks at the Financial Times, I don’t have to (click here for the video). But let’s take a look at some of these charts to tee this up:
Indeed, this view shows there’s a record amount of cash available. But when you look at it on a debt-adjusted basis…
Share buybacks seem to be the most obvious use of the excess cash at the moment. And with good reason. The prospects for future growth don’t look particularly good at the moment. So if you were going to do fundamental analysis of equities right now via a dividend discounting model (let’s use the Gordon Growth Model as an example):
Your denominator gets larger as the spread between required rates of return and growth rates expand. And as a result, the valuation for the stock is lower. If this sounds like a bearish case based on fundamental analysis, it is. How do you boost the price in this event? Simple: demand a lower rate of return. Good luck in getting your investors to go along with that.
But let’s try to take this train of thought and think strategically. If you’re a corporate Treasurer or CFO and view the economy and your business the same way, that means you would be expecting P/E multiple compression: prices fall while earnings level off and growth rates turn anemic. All of which leads to an interesting question: why do a buyback now if you can get more bang for the buck later? The case could be made for saving some dry powder.
As always, feel free to leave a well-reasoned, on point comment.