|»5 Minute Wrap Up by Equitymaster|
On This Day - 14 FEBRUARY 2011
What should Infosys do with its cash?
In this issue:
-------------------------- How to Profit from Futures? Ask Asad himself! --------------------------
Why do these companies need so much cash? Why don't they just pay it off to shareholders as special dividends? Isn't holding so much cash a waste given that this asset earns returns of no more than 4-5% (in India), while the business can earn 14-15% from its operations?
We don't think so! In fact, the comparison of 4-5% returns for cash with the 14-15% operational returns that a business can earn by employing this cash isn't correct. This is like comparing apples to oranges. Like a business must earn around 14-15% returns annually to justify its cost of equity capital, the cost of cash lying on the balance sheet must be equated only with what 'cash' can earn. And that rate is around 4-5% in India. So cash just needs this much return to break even. And thus, it is 'not' an unyielding asset on a company's balance sheet, unlike the popular perception.
But this does not mean that all companies must hold on to high levels of cash. Not at all! To resolve how much cash a company needs, you must understand what the company can do with its cash. If it earns strong return on equity by employing it into its business (like Infosys or Apple do), high cash isn't a problem. But for a company that is prone to making bad investments or overpaying for acquisitions, cash is safer in the hands of its investors.
Sachs has emphasized on India's solid footing when it comes to sustaining long term growth. But he has also warned that the quality of labour cannot improve without appropriate government policies. Not the ones formulated in the past decade for freeing up the economy. But the ones that can take India a step ahead in its goal of becoming an economic power to reckon with. Policies that can ensure that labour force is skilled, employable and healthy. Also ones that can help millions of middle class Indians contribute to the economy's growth. This will entail improvements in social and physical infrastructure.
Most importantly, Sachs believes that India cannot copy the policies from the US or China or any other economy. But needs to develop them in house to ensure that the country's long term needs are met. "You cannot read it in the book, you cannot take it off of a shelf, you are going to have to invent it. This is exciting on one side, but also rather difficult." These words from Jeffrey Sachs sum it up well.
This argument could well be correct if one believes that economic prosperity is nothing but an increase in GDP numbers. However, Doug Casey, a noted financial writer implores you to take a look at things from a different perspective. He has argued that such an activity is nothing but a sham. This is because he believes that digging and refilling trenches does not improve the living standards of people and does not increase the real wealth of the society. And hence, such an activity should not be encouraged at all.
Casey has further noted that US President Obama's policies are nothing but akin to doing what Keynes highlighted. He believes that Obama is trying to solve a problem of overconsumption and debt with more overconsumption and debt. Thus, there is no way that the living standards of US can improve with such measures even if the GDP does. To sum up, Casey has made a sober reminder that we are not out of the woods yet and a depression greater than The Great Depression could actually be ahead of us.
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