Companies are sitting on a lot less cash than they were last year, largely because they're spending it on share buybacks and corporate dividends.
While shareholders may be chuffed by that news, the slumping economy, surging interest rates and a credit crunch may mean US firms come to regret reducing their cash buffers.
The largest companies in the S&P 500 are still sitting on a decent stockpile of currency, but the decision to reward investors instead of paying down debt could mean corporations are overly focused on short-term stock gains.
What's happening: A new report from Moody's Investors Service finds that nonfinancial companies' corporate cash declined 12% last year to $2 trillion.
The cash went toward rewarding investors: Share buybacks rose 31% and dividend payments were up 10% last year, found Emile El Nems, vice president for Moody's Investors Service.
There was also a noteworthy 18% increase in capital expenditures — long-term investments in business growth.
But debt was flat year over year, meaning that companies didn't use much of their cash reserves to pay down outstanding loans. In fact, the tech sector accounted for the highest amount of cash held with 34% last year, but also the highest percentage of debt outstanding, with 12%, according to Moody's.
Profit pressures on corporate borrowers are intensifying at a rapid pace as business costs remain elevated while consumer demand wanes amid the prospects of an economic downturn.
High borrowing costs because of interest rate hikes by the Federal Reserve and an uncertain economic outlook mean that credit is getting more expensive and harder to find. Recent turmoil in the mid-sized banking sector only exacerbated those problems.
"The global cost of capital is now significantly higher than in the last few years," said Ben Lofthouse, head of global equity income at Janus Henderson. "When companies could essentially access finance at almost zero cost, there was a huge incentive to issue debt and buy back shares as this added immense value," he said.
Now that it's more expensive to borrow, companies in the US should reconsider the amount of money they're spending on buybacks, he added.
"One would argue that in a higher rate environment, it's more beneficial to keep cash on the balance sheet ... because you can generate a decent return on your cash rather than burning a hole that will require you to go out and borrow money at higher rates," El Nems told Before the Bell.
Last year was a remarkably bad year for markets, with the S&P 500 dropping nearly 20%. If companies believed that there was a price mismatch in their stock value and their actual value, they would prioritize buying back shares of their own stock at a discount, he said.
Buyback announcements reached a new record of $1.22 trillion last year, and they're on track to beat that high in 2023, according to Bank of America analysts. The S&P 500 is up more than 14% so far this year.
The rapid growth in buybacks is not a one-year phenomenon, either. Buybacks have almost tripled in value since 2012 (+182%), according to recent data from Janus Henderson.
Why it matters: Buybacks, say critics, are a tool that allow ultra-wealthy executives to manipulate markets while funneling corporate profits into their own pockets instead of the economy. Preventing companies from repurchasing their own shares, they argue, would free corporate cash to invest in growth and raise wages instead.
US President Joe Biden has called for a quadrupling of the tax on buybacks.
Corporations counter that they use repurchases as a way to efficiently distribute excess capital. Limiting buybacks, say supporters, could reduce the liquidity in stock markets and hurt share prices. Executives typically use buybacks to reduce the number of shares available for purchase, thus increasing demand for their stock and earnings per share.
Still, "buybacks cannot always be relied on to enhance shareholder returns," said Lofthouse. "Their discretionary nature makes them more volatile - as evidenced in 2020's Covid disruption when they fell dramatically."
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