To its credit, the WSJ did some serious quantitative work in an effort to determine whether Blackrock’s Larry Fink is correct that companies are paying out too much money to shareholders while starving capital investment. Fink is right, the Journal concluded. However, scrutiny of the WSJ’s own data points toward the opposite conclusion. Capex is not, in fact, being starved, and the relationship between capital spending and capital payout is similar to the 2003-2008 business cycle. Which is not at all surprising, if we think about the “real world” out there. We had a capital spending boom in the energy sector over the past few years; pharma companies big and small are spending heavily to develop new drugs; giant tech companies such as AMZN, FB, AAPL, MSFT, IBM and GOOG are spending heavily on server farms, warehouses, and R&D. Not exactly a capex drought.
The Conclusion . . .
The article, titled “FIRMS SEND MORE CASH BACK TO SHAREHOLDERS,” opens with its conclusion: “U.S. businesses, feeling heat from activist investors, are slashing long-term spending and returning billions of dollars to shareholders, a fundamental shift in the way they are deploying capital. Data show a broad array of companies have been plowing more cash into dividends and stock buybacks, while spending less on investments such as new factories and research and development.”
The WSJ Data . . .
“An analysis conducted for the Wall Street Journal shows that companies in the S&P 500 Index sharply increased their spending on dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over that same decade, those companies cut spending on plants and equipment to 29% of operating cash flow from 33% in 2003.”
What Really Happened . . .
That sounds pretty bad: a “fundamental shift” as capex is “slashed” while companies are “plowing more” into dividends & buy-backs. But there are a couple of problems:
- The data presented are based on shares of cash flow rather than absolute levels, so they simply cannot support the flat statement that firms are “slashing long-term spending.” If the share of cash flow spent on capex falls modestly while cash flow rises capex may increase, perhaps substantially. That is what actually occurred.
- The WSJ focuses on the end points (2003, 2013) while ignoring the business cycle, which drives capital payouts. The recent rise in payouts is cyclical not secular; a similar pattern occurred from 2003 to 2008. Said differently, the big rise in payouts trumpeted by the Journal comes from comparing a cyclical trough (2003) and cyclical peak (2013).
A Closer Look at the WSJ Data
Capital spending as a share of cash flow for the median firm: The 2013 figure of 28.7% is not particularly low—modestly below the 2003-2013 average of 29.5%. As noted, this metric is share of operating cash flow, so it may decline not because capex is weak but because cash flow is strong. Profits were, in fact, strong in 2013 at 117% above the cyclical low in 2009. Conversely, the 2003 figure was probably inflated by weak profits at the beginning of the economic expansion; 2003 S&P 500 profits were only 26% above the cyclical low in 2001.
Capital payout as a share of cash flow for the median firm: This metric was 17.7% in 2003, soared to 44% by 2008 as companies increased buy-backs and dividends, and then collapsed to 18% in 2010 as companies hoarded cash during the financial crisis. It has since climbed to 36.1% as dividends and buy-backs have increased, in normal cyclical fashion. But this metric is still below the 2007-2008 level, belying Larry Fink’s claim that activist investors are forcing companies to pay out too much capital.
If schools of journalism, like some business schools, had “case studies” this one would be titled, “Critically Scrutinize and Analyze your Data Before you Write About It.”
Copyright Thomas Doerflinger 2015. All Rights Reserved.