More than $2 trillion in cash distributions will be gifted to shareholders by S&P 500 CEO’s this year. More than ever before. But why?
Why do CEO’s distribute cash to secondary market speculators? These speculators haven’t provided any capital to the balance sheet and haven’t added to the income statement or cash flow statement of the companies they are speculating on. So why do CEO’s spend so much effort and capital appeasing them?
Market cap is the benchmark by which a company distributes cash (i.e. div yield). But market cap, as determined in the secondary markets, is a theoretical asset that doesn’t generate revenue, profit or cash flow for the firm. Meaning cash payments are tied to an ‘asset’ that has no relevance to a firm’s operations.
Paying dividends against an non-producing asset i.e. market cap that generates no return for the company is incredibly destructive. There becomes a dangerous disconnect between the return on capital the company raised/invested and the cash distribution.
In this sense, market cap is a massive hindrance to the firm’s capacity for productive investment as capital is eaten up paying out against an asset that hasn’t generated any return. The destructive force of this connect is exacerbated by the stock buy backs whose sole purpose is to drive market cap higher.
And for what benefit? What does a higher market cap or a higher valuation do to improve the operation and long term success of the business? Historically market cap was a represenation of operational performance and expected future growth but it has now become the objective.
Apple’s numbers are mediocre. But they are distributing $110 billion in cash this year so it doesn’t matter. They hit a trillion dollar market cap. That puts its price-to-sales in line with Amazon, which has a 3 year revenue growth rate 7x higher than Apple’s (32% vs. 4.5%). Amazon’s growth rate continues to accelerate while Apple actually lost overall marketshare dropping from second largest to the third largest seller of smartphones, something that hasn’t ever happened. And so why would a firm that is losing marketshare not be putting its capital to work?
The proof is in the pudding. Amazon doesn’t distribute cash to speculators. It attracts speculators by driving expected future growth. The rest of the market is attracting speculators by paying them cash. In effect, CEO’s are investing in market cap today rather than growth tomorrow. The result is that Amazon is in a league of its own, trouncing incumbants in any sector it enters because it invests in being better.
Adding to the absurdity is that these disconnected and disproportionately large cash payouts are going to a group of speculators that have never contributed to the balance sheet, income statement or cash flow statement. Buffett via Berkshire’s share of Apple’s $110 distribution is more than $6 billion. Why?
Note in the following chart the left tail of the chart is the Great Depression era and the right side is today.
The moral of the story is that when market cap becomes the objective of capital rather than a representation of productive capital allocation, productive investment is replaced with financial investment.
When market cap is being driven by something other than expected future growth derived from productive investment it is coming at the cost of expected future growth due to lack of productive investment. Read that again.
And look, if just one company was doing this it isn’t an issue but when all corporations are doing this the result is financial market acceleration and macroeconomic deceleration and ultimately contraction. Sound familiar?
Markets have accelerated to record highs while economic growth has decelerated to record lows.
At this point financial markets require perpetual money injections to prevent market cap from collapsing. And so the economy simply cannot compete with financial markets for available capital.
Enter the Fed with rate hikes and the end of the bubble cycle. A market cap reset is required for future growth. The Fed is aware and the beginning of this bull cycle end is now in play.
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Author: Tyler Durden