In the aftermath of the global financial crisis, companies around the world have accumulated trillions of dollars in cash on their balance sheets. As far as investors are concerned, now is the time for companies to start using that cash to create shareholder value, according to a recent survey by The Boston Consulting Group.
As the economy has improved, investors have grown increasingly bullish about the prospects of global equity markets.
The percentage of respondents who said that they were “extremely bullish” or “bullish” about equity markets grew from 15 percent in 2009 to 53 percent in 2011.
Nevertheless, many foresee an extended period of below-average growth and total shareholder return (TSR). And concerns about broad macroeconomic trends have fed an undercurrent of doubt about the long-term prospects of the economy. For example, a large majority of the survey respondents—82 percent—are “somewhat concerned,” “very concerned,” or “extremely concerned” about the impact of high U.S. debt levels on equity markets.
In this improving—but still highly uncertain—environment, there has been a consistent “ return to quality.” Investors are interested in putting capital into companies with high-quality management teams, clear sources of competitive advantage, strong and sustainable free-cash flow, and credible long-term plans for delivering value through profitable growth.
Investors recognize, however, that in a period of slow GDP growth, many companies will not have strong growth prospects. As a result, free-cash-flow returns to shareholders are becoming an increasingly critical component of the investment thesis. Indeed, investors assume that cash returns will make up a relatively larger portion of TSR than in the recent past. And many want those returns in the form of dividends rather than share buybacks.
Given these priorities, it is more important than ever that public companies develop and communicate a clear and compelling investment thesis, in which an organization’s business, financial, and investor strategies are carefully aligned. Although, in recent years, investors have seen some improvement in investor communication, 65 percent of respondents said that the companies they follow are not well aligned across these three dimensions.
All That Cash
The findings of this year’s survey need to be understood in light of the fact that global corporations today are sitting on unprecedented amounts of cash.
“The global financial crisis inspired widespread concerns about liquidity, causing companies to begin hoarding cash,” says Jeff Kotzen, a senior partner in BCG’s New York office and lead author of the study. “This trend was accelerated by the many cost-cutting initiatives that companies pursued during the downturn to improve profitability in the tough economic environment. As a result, companies worldwide are showing trillions of dollars of cash on their balance sheets.”
In 2010, for example, total cash and equivalents at the nonfinancial companies in the S&P 500 were just over $1 trillion, representing approximately 10.9 percent of assets, on average, 14 percent of revenues, and 10.8 percent of market capitalization—the highest levels in two decades. When banks and the rest of the 9,500 U.S. public companies were included in the tally, the total amount of cash on hand was in the neighborhood of $9 trillion.
Responses to the BCG survey indicate that investors believe it is now time for companies to start putting that cash to work to create shareholder value. When asked how they wanted companies to use their excess cash, the top priority was, overwhelmingly, “organic investment” in profitable growth (selected by 79 percent of respondents) But if a company doesn’t have clear opportunities to invest in growth, investors want it to start returning its cash to its investors. “Accumulation of cash on the balance sheet” came in dead last on our list, chosen as a top priority by only 8 percent of respondents. By contrast, “dividend increase,” at 33 percent, was the third-highest priority on
Investors also prefer dividends to share buybacks. “Stock repurchase program,” chosen as a top priority by only 19 percent of respondents, came in second to last. What explains this preference? The simple fact that the majority of respondents (68 percent) think companies do an extremely poor job of timing their share repurchases. “The strong preference of investors for dividends over buybacks helps explain why BCG research has consistently shown that dividend increases have a more positive impact on a company's valuation multiple than do share buybacks,” said Tim Nolan, a partner in BCG’s New York office and a coauthor of the study.
“Dividends’ growing importance to investors represents a major shift from attitudes in the past few decades, when capital appreciation accounted for the lion’s share of TSR,” added coauthor Frank Plaschke, a partner in BCG’s Munich office. During the past 25 years, dividend yield at S&P 500 companies accounted for only 2.5 percent of an average annual return of 9.9 percent. “But a higher reliance on dividends happens to be a reversion to a longer-term historical trend,” Plaschke continued. An analysis of the composition of TSR of the companies making up the S&P 500 from 1900 through 2010 shows that dividend yield accounted for nearly half of total TSR—4.6 percent of an average annual return of 9.5 percent.”
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