Should companies hoard cash or declare dividends? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Should companies hoard cash or declare dividends? 

A  A  A
In this issue:
»  This crucial, life-sustaining element will soon run out of supply
»  The effect of QE is diminishing
»  For the US, it's the retirement crisis now
»  Who will be the next 800-pound gorilla in the world economy?
»  ...and more!

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Let us ask you a simple question. Why do you invest in stocks? Why not put that money into bank fixed deposits instead? You assume the higher risk to earn higher returns, right?

So by investing in stocks, you are essentially handing over your hard-earned money to the company's promoters and managers. You expect them to earn you a return that is adequately higher than what is offered on relatively less risky assets.

But what if the company is sitting on a huge pile of cash? Should it keep the cash stashed in bank deposits? Or should it return the money to shareholders in the form of dividends?

Let's take the case of Apple Inc, the world's most valuable technology company. It has been exactly a year since it declared its first dividend. This year, it is widely expected that the dividend payout could be to the tune of US$ 15.7 bn. That would be over 50% higher than the previous year. It is worth noting that the tech giant is sitting on a massive cash pile of about US$ 137.1 bn.

For a while, shareholders of Apple have complained that the company is hoarding too much cash. That is, even after accounting for all its research, development and important investments in the future.

This brings a question to our mind. Shouldn't Indian companies that are sitting on a lot of excess cash return the money to shareholders? As per a leading financial daily, Indian companies are currently hoarding an idle cash pile worth Rs 5 trillion.

One must remember that idle cash tends to reduce the efficiency of capital. Why should the company park excess cash in bank deposits when shareholders can do the same if the money is returned to them? We believe companies should decide on the basis of Warren Buffett's test on dividends, 'Can you create more than one dollar of value with the one you retain?'

In the Indian context, we must remember that there are a few other reasons as well why companies tend to keep the surplus cash. On many occasions, they tend to hoard cash for prospective acquisitions. At other times, companies wait for the investment climate to get more conducive.

Both these points hint at regulatory and policy hurdles. In the first case, companies find it cumbersome to raise cash quickly on account of the maze of regulations. If raising capital can be made easy at a short notice, companies wouldn't be forced to hoard cash.

In the second case, projects have had to be cancelled or deferred due to lack of clearances and uncertainty about project viability. In other words, the government is somewhat responsible for the poor capital efficiency in the country.

If policymakers really want to put India back on the growth path, they need to create a business-friendly environment. If this is ensured, companies would be more willing to invest their surplus cash in productive assets. And this would, in turn, reward shareholders with better returns.

Do you think companies should return surplus cash to shareholders in the form of dividends? Please share your comments or post them on our Facebook page / Google+ page

01:30  Chart of the day
India is a country of paradoxes. And so is its economy. We take pride in the fact that India has the highest youth population. We keep telling ourselves that this demographic dividend will keep India's growth prospects intact. But the ground reality appears to be very different.

As per an article in Business Today, India is facing a rising shortage of skilled labour. Against a target of 8.5 million people for FY13, the National Skill Development Corporation and the various ministries managed to achieve just 16.5% of their skilling target till mid-November 2012. By 2022, the 17 ministries have a huge target of skilling 350 m people. The chart of the day shows the expected shortfall of skilled labour force across some major industries in 2022.

This raises some major worries about India's future. If the teeming millions of India's youth are not skilled and productively employed, it is set to have far-reaching socio-economic repercussions on the country.

Souce: Business Today

A chain, it is said, is only as strong as its weakest link. Thus, in order to gauge a chain's strength, all you have to do is identify the weakest link. And voila, your problem is solved. A reputed fund manager who answers to the name of Jeremy Grantham believes he has finally located the weakest link in the human population chain. And what exactly is this weakest link? Well, it's none other than the humble element of Phosphorous.

You see, Mr Grantham is of the view that our planet can only support about 1.5 billion humans. Thus, the current population of 7 billion means that we are way too far along the population curve. And what has made this population explosion possible? Well, it is the rampant use of fertilisers that has helped us produce ever more food from the same quantity of landmass. Unfortunately though, phosphorous, a key ingredient in the manufacture of fertilisers has no substitute to speak of. And there is no infinite availability of it on our planet. In fact, some experts predict that we could hit peak production of phosphorous as early as 2030.

Thus, with production of fertilisers severely constrained, could we see a day where billions of people are left starving? The situation is certainly dire. But it is by no means unsolvable according to us. The ingenuity of us humans has always got us out of such calamities in the past. We don't see any reason why it should be different this time around. But yes, there's only so many mouths that our planet earth can feed. As a result, we should definitely guard against any sizeable increase in its population. And also use the resources that we've got wisely.

Post the global financial crisis, the US Fed resorted to three massive rounds of quantitative easing. The rationale was that more money in the hands of the people would induce them to spend and propel the economy back. Nothing has been further from the truth. The US economy has failed to recover meaningfully and unemployment and job creation still remain significant challenges. So what has QE really achieved?

Take commodities for instance. The first 2 rounds of QE did help in propping up commodity prices, but post QE3 in September 2012, commodity prices have been declining. This just reiterates the fact that commodity prices follow the economic cycle. With the latter not really recovering, prices have remained depressed.

So the only beneficiary of QE programs seems to be equities. Indeed, all QE seems to have done is put more money into the system which has found its way into equities. So while the fundamentals remain poor, equity prices in the US have soared and contributed to a false sense of well-being.

First they had the sub-prime crisis which eventually led to the stock market crisis. Now, when the markets have reached new highs and the crisis seems to have been ebbed they have the retirement crisis. It seems that the crisis era for US is not going to get over soon.

As per a report by Employee Benefit Research Institute (EBRI) 57% of the US workers have reported total household savings of less US$ 25,000. This figure stood at 49% in 2008. Thus, the number of people being exposed to retirement risk has increased.

The survey also pointed out that about 28% of Americans feel that they might outlive their savings. This is the highest ever figure in the last 23-year history. To further worsen this situation, it is believed that the life expectancy of an average American is on a rise. This not only increases the retirement risk but also puts strains on the pension plans doled out by corporates.

While the above forecasts reveal that US is likely to face retirement risk it is also important to understand why such a situation may have arisen. One cannot save enough if either he doesn't earn enough or if he lives beyond his means. The current slowdown has meant that the incomes of US citizens have fallen. And this increases retirement risk. But we feel that it is also got to do with the non-saving culture that has been prevalent in US. However, with an aging population this trend will certainly have to change for the better.

An economic power house! An 800-pound gorilla in the world economy! These pseudonyms were comfortably associated with the US for the longest time. But ever since high unemployment, slow growth, heavy debts and weakening dollar gripped the economy, all heads have turned to China.

A recent publication - The Leaderless Economy, authored by the likes of Paul Krugman and Martin Wolf delves on this issue. But there is more to it. It stresses on the fact that a dominant global power is necessary to bring the world's economies back into balance. China's export-oriented growth strategy, with its artificial suppression of the yuan, is to an extent responsible for US' fall from grace in the economic order.

However, the oriental economy has its own set of problems. Hence, although the US is far from being the world super power, China, if it is ever to assume the mantle of leadership, is not ready yet. As per Bloomberg, the book offers some interesting, albeit confusing arguments about the US-China tussle.

In the meanwhile, the Indian share markets hovered below the dotted line throughout today's trade. At the time of writing, BSE Sensex was down by 75 points (0.4%). Barring FMCG and healthcare, all sectoral indices witnessed losses. Asian stock markets displayed mixed investor sentiments with China as highest gainer and South Korea as top loser.

04:50  Today's investing mantra
"Over the very long term, history shows that the chances of any business surviving in a manner agreeable to a company's owners are slim at best." - Charlie Munger

  • Charlie Munger - Investing Lessons
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    5 Responses to "Should companies hoard cash or declare dividends?"


    Mar 21, 2013

    The investor invest into company[ shares etc] with a view to earn return over & above bank rate. Basically, the concept of earning is income dividend' and 'bonus'. But income from selling stocks at more than buy price is nothing but drawing money from once's pocket, other than the company.Hence I strongly feel that compny should be made mandatory to pay dividend.If money for new project/expansion, etc. required, the company may raise by way of IPP,BONDS ETC.



    Mar 21, 2013

    How will the Government (Politicians and bureaucrats) allow the empowerment of the HNW citizens to decide their future. Their job is to create impediments and hurdles and test the citizens capability to grease the machinery for their smooth running and not the economy nor the nation. Hence hoarding the cash for future investments waiting for conducive investment environment is either a myth or a fantasy.



    Mar 21, 2013

    Returning money to investor is sometime showing lack of confidence in self capability to earn higher if retained so if in short term business environment is not so friendly one should show little patience for future opportunity to be availed with cyclical slight change in business environment as transferring money in unprofessional hands could become reason for lost of it in absence no other prudent option.



    Mar 21, 2013

    In the prevailing uncertain economic and political scenario, maybe it's prudent for companies to hold cash rather than distributing dividends, after all using the available cash is anyday better than raising debt from beanks for large-scale acquisitions. As for political bureaucracy,to bring about transparency in transactions, govt should encourage and establish well-defined criteria for approvals/sanctions , leaving very little in terms of subjective judgement--in this way, even if politicians want, they cannot circumvent the law. regds


    R V Iyengar

    Mar 20, 2013

    It is stated that the Indian Companies have a cash balance of Rs 5 trillion which translates to about 500 billion dollars.
    It is also well known that the growth is stymied because of liquidity crunch. Government has been goading RBI to lower rates. The rates have been lowered by a mere 25 basis points which translates to about 4 billion dollars at best.
    If even 10 % of the cash hoard with the companies can be brought to market it would release a substantial 50 billion dollars. If the government could bring about a mechanism by which this cash can be released it would work wonders.

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