The most controversial use of corporate cash will hit a $1 trillion milestone.
There are four basic things companies can do with the cash they accumulate: 1) they can reinvest in their business by growing their operations; 2) they can acquire another business; 3) they can return it to shareholders in the form of dividends; or 4) they can return it to shareholders by buying back stock.
Since the financial crisis, lackluster growth prospects have prevented corporations from aggressively investing in their own businesses. While there has been a moderate amount of merger and acquisition activity, the big story of the ongoing economic recovery has been companies shoveling out cash in the forms of growing dividends and increased buybacks.
“Since 2009 total payouts to shareholders, which includes dividends and buybacks, have increased by 20% per year for the S&P 500,” Barclays’ Jonathan Glionna said. “We estimate total payouts for the S&P 500 will reach $1 trillion for the first time ever in 2016. This will include approximately $400 billion in dividends and $600 billion in gross share repurchases and will culminate six years of substantial growth in payouts. As recently as 2010, total payouts were just $500 billion per year.”
Deploying cash through dividends and buybacks is controversial since it is not as productive to the economy as business investment. Much of this money that is returned ends up being saved by shareholders.
Buybacks are particularly controversial because they inflate earnings per share by reducing share counts. The controversy is made that much more heated because companies have been increasingly buying back shares with borrowed money.
The real problem: Cash payouts are outpacing earnings
Glionna believes this trend of booming cash payouts is plateauing as they are now exceeding the pace of corporate profits.
“The growth rate of payouts has far exceeded the growth rate of earnings or cash flow, leading to a high payout ratio and elevated borrowing needs,” he said. “The result has been a rise in leverage, with companies in the S&P 500 adding $1 trillion of debt during the last three years.”
Without a big pop in earnings, this growth in cash payouts is unlikely to be sustained.
“Over the last few years payouts have exceeded earnings for the S&P 500, which is rare,” Glionna observed. “It almost happened in 2014, when the total payout ratio was 99%. In 2015, it did happen. It will happen again in 2016, based on our estimates, as net income is likely to be less than $900 billion against $1 trillion of dividends and buybacks.”
Before the 1990s, cash payouts were far more conservative.
“Prior to 2015, companies in the S&P 500, in aggregate, had paid out more than they earned only six other times during the last 50 years,” Glionna said.
This does not bode well for the stock market, whose marginal buyers have included corporations buying back stock and investors seeking growing dividends.
Sam Ro is managing editor at Yahoo Finance.