Mounting piles are tempting some to time the market.
The last thing a treasurer wants to do is try to time the markets. But improving cash flows at many firms are tempting them to do so. These, and lack of attractive business investment opportunities have put many companies in the unpleasant position of seeing their performance dragged down by too much cash. That has spurred interest in share repurchases or dividend increases.
The trouble is, pre-crisis repurchase activity was often a value-destroying activity. Companies bought back their shares at prices at or near the top of the market, and, in the case of leveraged recapitalizations engineered to avoid the embrace of leveraged buyout shops, took on onerous levels of debt to do so.
Share prices now are generally looking pretty lofty, especially in light of the weakness in business and economic fundamentals. The S&P 500 is trading at about 20 times the trailing earnings of its constituent companies. Granted, that’s less than 27 times or more prior to the credit crisis, but well above the historic average of around 16 times. This means companies would have to throw a good measure of caution to the wind to buy back their shares now, essentially betting that no retrenchment is in the cards.
Dividends, too, are problematic. First, if your share price is high or has rallied substantially, the amount you pay out in dividends probably won’t make much difference to the total return of your shareholders—in fact, they may bemoan the money that leaks out via taxes. In fact, the New York Times reports that dividends fell for the first time in half a century in 2009.
Offsetting this is the fact that the capital gains on most shares this past decade was wiped out by the 2007-09 market carnage, making dividends look more attractive to shareholders. Unfortunately, an increase in dividends is not always seen as a bullish sign for a company—investors interpret it as reflecting a lack of other business opportunities. But if fortunes reverse, and a company has to cut its dividend, investors typically run for the hills.
Corporates, therefore, face a nontrivial strategic challenge. Watching returns dragged down by a mountain of low-yielding cash is certainly no fun. But betting on the stock market’s direction in such uncertain times looks like a fool’s game.