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Capital Spending Boom Is No Great Boost to Capital Markets

Akane Otani

U.S. companies are ramping up spending on their businesses at the fastest pace in years, a long-awaited development after years of tepid growth.

Spending on factories, equipment and other capital goods by companies in the S&P 500 is expected to have risen to $166 billion in the first quarter, up 24% from a year earlier, according to Credit Suisse data going back to 1995. It is on track for the fastest pickup since 2011 and a record for the first quarter of a year. The jump has been aided by the U.S. tax-code overhaul, which is putting more cash in companies’ coffers.

The biggest spenders run the gamut, from technology behemoths such as Google parent Alphabet Inc. to car maker General Motors Co. and oil giant Exxon Mobil Corp.

Investors and economists agree that capital expenditure, or capex, is good for long-term corporate profits and the broader economy, which has languished for years without such spending. Yet history suggests it also could pressure share prices—leaving investors questioning whether it is worthwhile to bet on companies with costly projects that may not pan out, especially at a time when many are wondering whether corporate earnings are as good as they will get in this economic cycle.

“When it works, it’s a home run. But for investors who are sometimes much more short-term oriented, it’s easy to understand why a dividend increase that I’ll get next month is a little more exciting than capex, which might not yield me anything for a long time,” said Dave Donabedian, chief investment officer at CIBC Atlantic Trust Private Wealth Management.

The jump in capital spending comes as companies whittle away at massive stockpiles of cash—something that has allowed them to funnel money into their businesses and increase their dividends, as well as buy back their shares at a record pace. Buybacks often provide a short-term boost to stock prices, although they have been maligned by critics who feel that, unlike capex, they do little to boost long-term profitability.

Data suggest that shares of companies with large and growing capex tend to underperform the broader stock market—which could weigh on returns just as the market has become more volatile.

Shares of the 20 companies in the S&P 500 that spent the most on capex in the first quarter are up 0.5% for the year, trailing the broad index’s 1.4% gain, according to analysis of data from S&P Dow Jones Indices. The trend becomes even more pronounced over longer time horizons: Since 1986, companies with the highest capex-to-sales ratios have underperformed the S&P 500 by more than 2 percentage points on average each year, according to Bank of America Merrill Lynch.

As a share of gross domestic product, private nonresidential fixed investment—a commonly used proxy for capex—has been rising for more than a year. It remains below levels hit in 2014, when soaring crude-oil prices pushed energy companies to spend heavily, according to a Credit Suisse analysis of government data.

The capex boom could be a tonic for a stock-market lull that has kept the S&P 500 and Dow Jones Industrial Average in a narrow range for months, and offer a further boost to corporate earnings. But research shows it isn’t that clear-cut.

“Greater investment and high valuations imply that we probably won’t experience a stock market boom in the next couple years,” said Christopher Anderson, a University of Kansas professor. His 2006 research found that companies that have the biggest increases in capital spending have subsequently had underperforming stock returns.

Capital spending has been growing rapidly in the tech industry, where companies that have seen some of the biggest share-price growth in recent years are becoming increasingly capital intensive. More than half of the growth in first-quarter capex spending can be attributed to the tech sector, Credit Suisse data show.

Investments in data centers, undersea cables and New York City real estate pushed Alphabet’s capex tab in the first quarter to $7.3 billion—the most of any S&P 500 company, and nearly triple what it spent a year earlier.

Although Alphabet’s quarterly profits surged thanks to strong demand from advertisers, its shares tumbled 4.8% on the day following its earnings report as investors questioned the sustainability of the costliest spending spree in the firm’s 14-year history as a public company. The stock has since rebounded. The company has said it believes these investments will create shareholder value.

Investors have been wary of other companies ramping up spending.

Shares of the second-biggest capex spender in the S&P 500, GM, have slumped 9.9% this year in part as the costs tied to a revamp of its pickup trucks—the most extensive such redesign in two decades—have cut into profit.

In the energy sector, shares of companies that have prioritized boosting buybacks and dividends have tended to outperform those deploying cash to drill for more oil. ConocoPhillips stock has surged 28% even as Exxon Mobil, the seventh-biggest capex spender in the first quarter, has fallen 2.2%.

Not all big capex-spending companies have struggled in the stock market. Shares of e-commerce giantAmazon.com Inc. have soared 35% in 2018, adding to double-digit percentage gains in 2017, as the company’s sales growth outshone increased spending on warehouses, expanding its delivery network and amping up its digital offerings.

“You do not want to see companies spending above their normal trend. That historically has been negative for stock prices,” said John Bailer, a senior portfolio manager at BNY Mellon Asset Management North America.

The cut to the corporate tax rate and a deregulatory agenda in Washington are giving businesses more certainty about how to spend their growing cash piles. But rising interest rates and the threat of more restrictive trade policies could restrain economic growth. Economists surveyed by The Wall Street Journal expect a U.S. recession could come as soon as 2020.

To some investors, the murky outlook is another reason to gravitate toward companies that can deliver steady shareholder returns.

Mr. Bailer of BNY, who said he is investing in companies that limit spending while focusing on boosting dividends and buybacks, is bullish on banks, refiners and technology companies. “If I can get a bigger percentage of [a company’s] cash flow, I think that is a great thing,” he said.

Write to Akane Otani at akane.otani@wsj.com, Ben Eisen at ben.eisen@wsj.com and Chelsey Dulaney at Chelsey.Dulaney@wsj.com



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