Quite often, investors get mired in the particulars of individual stocks. Sometime its best to take a step back to observe broad trends. Despite our predisposition for individual narratives, the returns and volatility of most stocks are largely determined by broad themes--be they macro or factor-oriented. For this post, I take a look at corporate uses of cash over the last two decades, with a focus on the last few years. The findings suggest that it is more important than ever for equity investors to evaluate quality metrics like balance sheet strength, quality of earnings, and corporate allocation policies.
The chart below totals corporate uses of cash for buybacks, debt issuance, and dividends for U.S. companies having a market cap greater than average (around $8 billion and up). For the twelve months ended August 2016, cash dividend payments came in at $331 billion (grey), net stock buyback activity at $384 billion (red), and net debt issuance at $393 billion (blue line, axis is inverted).
There are a few trends of note. First, August 2015 was the first time since 2009 that net debt issuance exceeded both dividend payments and net buyback activity. Second, to get an aggregate sense of what corporations are doing with cash, I combine these three uses of cash in what I call "net cash to stakeholders" (net buyback activity + cash dividends - net debt issuance). In the chart below, you can see that despite the fact that dividends and buybacks are near all-time highs, net cash returned to shareholders has fallen by about a third since its peak in December 2014. This has largely been the result of a huge increase in net debt issuance since that time.
Of course, one would assume the carnage in the Energy sector is a force here, and it is. In mid 2014, the most recent cyclical high in oil prices, the Energy sector was returning $50 billion cash per year to stakeholders through dividends and buybacks, net of debt issuance. As of August 2016, the sector is still paying $40 billion per year in dividends, but is funding those dividends through net stock and debt issuance of $48 billion. Not a pretty picture.
Underlying all of this is a 22% decline in aggregate net income since late 2014 (see chart below). This decline is most likely due to the sharp appreciation in the value of the U.S. dollar between July 2014 and March 2015, which I wrote about here, and the downturn in the price of oil over that same period. Clearly, a decline in oil prices hurts Energy earnings. Less recognized is that nearly half of S&P 500 revenues come from overseas. Therefore, a strengthening dollar can substantially hamper U.S. company earnings and long term competitiveness.
From a fundamental perspective, a spike in the price of oil and a depreciation of the U.S. dollar would certainly be a welcome tailwind for stocks. In the meantime, investors would likely be well-served to stray away from companies that are overly levered or are taking on significant amounts of debt.
Data note: All time series in this post exclude Financials.