|»5 Minute Wrap Up by Equitymaster|
On This Day - 13 MAY 2011
Is cash no longer 'king'?
In this issue:
Is it better to invest in gold or stocks? ...
'Gold Bug' Bill Bonner, answers these questions for you in the exclusive publication - The Guide to Gold
As you can expect successful companies generate piles of cash. They find themselves throwing up more cash than what they can attractively deploy. But, when this cash hoard runs into billions, investors start asking questions. European and US companies currently hold a total of around US$ 2 trillion in excess cash. They are under pressure from investors to distribute these accumulated mountains. Indian born, Infosys has also saved up US$ 3.8 bn over the years. But, instead of being an asset or a war chest, this cash pile has become a liability for the company. Jealously eying its bank balance, and high operating margins, clients are asking for lower billing rates from the tech major.
Companies like Infosys have one of two choices. They can either return the cash to shareholders or invest the money. Very often, companies are not able to find exciting enough opportunities to spend the cash. Rather than burning their fingers by making a hasty acquisition which may or may not generate returns, we are more in favour of the former.
But, some companies believe that distributing cash to shareholders is a bad reflection on management's ability to find profitable avenues for investment. We on the other had believe that companies should pay excess cash out to shareholders either through a share repurchase or through dividends. There is no fundamental difference in value created from either method. However, a share buyback offers a lot more flexibility to companies versus instating a higher dividend payout. When times turn bad, cutting dividends at a later date sends a negative signal to the market.
As an investor do you prefer the up-front benefits of dividends, or do would you prefer to offer your favourite company the flexibility of a share buyback?Share your comments with us or post your views on our facebook page.
Note: PCs stand for personal computers
Interestingly, Microsoft recently announced that it was acquiring Skype, the Luxembourg-based internet telephony provider for US$ 8.5 bn. In Indian rupees, it translates to about Rs 382 bn. That's a staggeringly huge amount considering the company is yet to make profits. The company has about 145 m users per month on average, out of which 9 m are paid users.
Experts are of the view that Microsoft has given a rich valuation to the company. This is a confirmation of the current trend where valuations of global tech deals have been steadily rising. Now, how do the Indian technology and e-commerce start-ups stand to gain from all this? The answer is that they can command better valuations too. Of course, India may not have start-ups of the stature of Facebook or Skype. Nonetheless, the trend will help them negotiate better and raise funds more easily.
So will a weak demand finally bring prices to sensible levels? While the agency expects prices to stay firm, we believe that the levels will be hard to sustain under a weak demand scenario. But there are caveats. If US decides to end tax breaks for oil and gas industry, it may stifle investment in new supply sources, pushing prices higher. As far as supply from OPEC is concerned, it will be better not to be optimistic.
The investment has played out better than perhaps even Buffett would have imagined. US recovery has continued to strengthen and the huge unexpected jump in oil prices has also worked to Burlington's advantage. Besides, the company's CEO is now answerable only to Buffett and this has enabled him to take decisions in the long term interests of the firm. Thus, Burlington's recent improvements could only be an indicator of things to come. Don't be surprised if the firm scales much greater heights.
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