S&P 500 Companies Spend 95% of Profits on Buybacks, Payouts

[Loren Pechtel]

Um, shareholders are not necessarily the wealthy. Indeed, if you are in he middle class you are likely a shareholder of many S&P 500 companies.

So because a tiny fraction of the shares are held by middle class people, it is not fair to say that this primarily benefits the aristocracy?

Your "tiny fraction" isn't so tiny once you look at indirect ownership--namely, pension funds.

 

[Loren Pechtel]

I'd certainly not expect 95% of the profits to be going back to investors. For the sake of the continued growth of the company, I'd at least want a fair portion of the profits to go towards R&D, facilities, training of employees, keeping trained employees around (aka benefits and pay), etc. Not sure what a 'fair' portion of profits is to be considered though. I have heard that major companies typically put 5% towards R&D, but even that is just heresy.

Little detail: How does R&D money normally get spent? Salaries etc. In other words, things that are counted before you decide what is profit. That 5% number seems reasonable to me but note what it actually means. It's more than 1/3 of their total profit + R&D.

 

[Axulus]

The US is top in R&D spending per capita (PPP):

http://en.wikipedia.org/wiki/List_of_countries_by_research_and_development_spending

 

[dismal]

Obviously they got to be the largest companies by being such wise stewards of their yearly profits.

I urge them to continue these pro-growth strategies.

I'm not sure why you would assume these companies are trying to grow and/or trying to grow is the best thing for them to be doing.

The evidence suggests they think it isn't.

We have now had now multiple posts across multiple threads on this topic and you have yet to offer a clear and concise rationale as to why companies paying out cash they make to investors this is a problem in any way.

It now seems like you have so little to offer in support of your position that you're not even trying.

 

[ksen]

The US is top in R&D spending per capita (PPP):

http://en.wikipedia.org/wiki/List_of_countries_by_research_and_development_spending

How much of that was government funded?

 

[Playball40]

See I'm not as concerned with the profit being disbursed to shareholders as much as I am about the obscene increase in "profit" at the expense of the worker, environment and economy. We've moved to a short-term, fast growth, shareholder is god and the rest of the stakeholders are nothing, mentality/environment.

 

[ksen]

Obviously they got to be the largest companies by being such wise stewards of their yearly profits.

I urge them to continue these pro-growth strategies.

I'm not sure why you would assume these companies are trying to grow and/or trying to grow is the best thing for them to be doing.

Well, they must think they at least have to grow their earnings per share otherwise why do stock buybacks instead of just doing all dividend payouts?

The evidence suggests they think it isn't.

We have now had now multiple posts across multiple threads on this topic and you have yet to offer a clear and concise rationale as to why companies paying out cash they make to investors this is a problem in any way.

It now seems like you have so little to offer in support of your position that you're not even trying.

Ok, I've had some fun in this thread so I'll serious answer you about this one without any expectation that you will actually engage on the subject.

You say the evidence suggests that these companies don't think using more of their profits to fund growth is the best use of their cash. I srs agree with you. I believe that they don't think funding future growth is worth it right now.

The reason I think that is the case is because they understand our economy is suffering from a lack of demand. If they don't think the additional future demand will be there then it makes sense to do something else with the money instead of building more capacity that's just going to sit around idle.

What they don't seem to understand, or maybe they do and they just don't care, is that they have a large part of the solution to the demand problem right in their overflowing bank accounts. If they used some of those record profits from the last decade to pay their people more demand would increase thus making investing in the business a better use of their funds than just returning it to shareholders in the form of stock buybacks and increased dividend payouts.

Am I saying don't do any buybacks or dividend payouts? No.

But surely there is a middle ground that would be better for the economy as a whole than returning 0% of profits back to shareholders or returning 95% of profits back to shareholders in the form of buybacks and increased dividends.

I suspect that part of the reason these big corporations are basically giving their profits away is the shortsightedness of the executives in charge of these corporations and the managers in charge of the big pension/hedge funds who have a very large part of their pay packages tied to bonuses that require a certain level of EPS in order to kick in.

^^That and $1.99 will get you a shitty coffee at dunkin' donuts.

 

[dismal]

The reason I think that is the case is because they understand our economy is suffering from a lack of demand.

I can guarantee you this is not what they are thinking. First, if they have had some economics courses they will find it an unintelligible assemblage of words.

Second, they mostly don't look at the economy and it's sufferings. They look at their own prospects to sell more of what they sell or do more of what they do and earn a return doing it that exceeds their potential other uses of capital -- one of which is distribution it to investors.

If they don't think the additional future demand will be there then it makes sense to do something else with the money instead of building more capacity that's just going to sit around idle.

Well, I think we can both agree they don't want to build factories that sit around idle. Otherwise, see above.

What they don't seem to understand, or maybe they do and they just don't care, is that they have a large part of the solution to the demand problem right in their overflowing bank accounts. If they used some of those record profits from the last decade to pay their people more demand would increase thus making investing in the business a better use of their funds than just returning it to shareholders in the form of stock buybacks and increased dividend payouts.

This is utter silliness. It's like the Henry Ford fallacy that refuses to die in spite of the fact in can't survive basic math. You don't improve your profits by paying your employees more so they can buy your products. 100% of the money you pay them comes out of your profits. <100% of the money you pay them is spent on your products. If you make wire hangers or foam fingers a tiny, tiny percentage of the additional money you spend on your employees will come back to you. It is a silly, silly, silly thing for a company to believe it should pay its employees more to increase the demand for its products. There may be other reasons why you might want to pay employees more, but this a very stupid one.

But surely there is a middle ground that would be better for the economy as a whole than returning 0% of profits back to shareholders or returning 95% of profits back to shareholders in the form of buybacks and increased dividends.

It does not benefit the economy as a whole for money to be spent on idle wire hanger or foam finger factories. It is better to return it to investors who will invest it in growing sectors of the economy. Or spend it on booze and whores.

I suspect that part of the reason these big corporations are basically giving their profits away is the shortsightedness of the executives in charge of these corporations and the managers in charge of the big pension/hedge funds who have a very large part of their pay packages tied to bonuses that require a certain level of EPS in order to kick in.

I work for an investment fund. We like to spend money to grow companies. Then there comes a time when the better move is to take money out. As I mentioned before investors consider the taking money out part pretty effing important. Indeed our investors invest in our fund because we send money back to them at some point. We reward our company managers for sending us more money out than we put in. Our investors reward us for sending them more money than they sent us. I am lead to believe we are not unique in this respect.

 

[ksen]

I can guarantee you this is not what they are thinking. First, if they have had some economics courses they will find it an unintelligible assemblage of words.

Second, they mostly don't look at the economy and it's sufferings. They look at their own prospects to sell more of what they sell or do more of what they do

Yes, like I said . . . they look at the potential demand for their product or services. And if they don't think the demand is there they will do something else with their profits. I don't know why you called what I said an "unintelligible assemblage of words" since you just restated it and said the exact same thing.

and earn a return doing it that exceeds their potential other uses of capital -- one of which is distribution it to investors.

How are they earning a return by buying back their stock, and artificially inflating short term EPS, or sending the capital out of the corporation in the form of increased dividends? What's the typical return on dividend payments to the company paying the dividends?

What they don't seem to understand, or maybe they do and they just don't care, is that they have a large part of the solution to the demand problem right in their overflowing bank accounts. If they used some of those record profits from the last decade to pay their people more demand would increase thus making investing in the business a better use of their funds than just returning it to shareholders in the form of stock buybacks and increased dividend payouts.

This is utter silliness. It's like the Henry Ford fallacy that refuses to die in spite of the fact in can't survive basic math. You don't improve your profits by paying your employees more so they can buy your products. 100% of the money you pay them comes out of your profits. <100% of the money you pay them is spent on your products.

And 100% of the money for capital improvements comes out of profits through either a direct buy or increased lease or debt payments. What's your point? Should "it 100% comes out of profits" be a reason to not invest in capital?

If you make wire hangers or foam fingers a tiny, tiny percentage of the additional money you spend on your employees will come back to you. It is a silly, silly, silly thing for a company to believe it should pay its employees more to increase the demand for its products. There may be other reasons why you might want to pay employees more, but this a very stupid one.

Sure, I guess it would be stupid to for Wal-Mart to think it would see increased sales if they paid their employees, who are also Wal-Mart shoppers, more money to spend at Wal-Mart.

More money in the pockets of consumers = more demand. It's a pretty simple equation.

But surely there is a middle ground that would be better for the economy as a whole than returning 0% of profits back to shareholders or returning 95% of profits back to shareholders in the form of buybacks and increased dividends.

It does not benefit the economy as a whole for money to be spent on idle wire hanger or foam finger factories. It is better to return it to investors who will invest it in growing sectors of the economy. Or spend it on booze and whores.

So no middle ground. Ok.

I suspect that part of the reason these big corporations are basically giving their profits away is the shortsightedness of the executives in charge of these corporations and the managers in charge of the big pension/hedge funds who have a very large part of their pay packages tied to bonuses that require a certain level of EPS in order to kick in.

I work for an investment fund. We like to spend money to grow companies. Then there comes a time when the better move is to take money out. As I mentioned before investors consider the taking money out part pretty effing important. Indeed our investors invest in our fund because we send money back to them at some point. We reward our company managers for sending us more money out than we put in. Our investors reward us for sending them more money than they sent us. I am lead to believe we are not unique in this respect.

And I am lead to believe that right now your business is doing more harm than good.

 

[coloradoatheist]

Yes, like I said . . . they look at the potential demand for their product or services. And if they don't think the demand is there they will do something else with their profits. I don't know why you called what I said an "unintelligible assemblage of words" since you just restated it and said the exact same thing.

Except this is the issue with every single product/business startup or growth. A business or a startup isn't saying, "Hey everybody has X dollars that they aren't selling, we'll sell to that" They are thinking. We are going to have to go after the dollars they are spending on the competition and they will buy our product instead.

Sure, I guess it would be stupid to for Wal-Mart to think it would see increased sales if they paid their employees, who are also Wal-Mart shoppers, more money to spend at Wal-Mart.

More money in the pockets of consumers = more demand. It's a pretty simple equation.

No it's not. Let's say that Wal-Mart gives its employees an extra $10, what percentage of that is going to come back to them? Even if their employee spends 50% of that money at Wal-Mart they are going to spending $10 to make $5. Since when is it a good business decision to spend $10 to make $5, and that's being generous.

 

[ksen]

Well, how much increased sales are they going to see from increasing their dividend payments?

 

[dismal]

Yes, like I said . . . they look at the potential demand for their product or services. And if they don't think the demand is there they will do something else with their profits. I don't know why you called what I said an "unintelligible assemblage of words" since you just restated it and said the exact same thing.

I'm not saying non-sensical things like "our economy is suffering from a lack of demand".

How are they earning a return by buying back their stock, and artificially inflating short term EPS, or sending the capital out of the corporation in the form of increased dividends? What's the typical return on dividend payments to the company paying the dividends?

This is also mostly non-sensical to me. There is nothing "artificial" about growing the EPS by having fewer S. This is the way ratios work.

Most companies have an assumption about their weighted average cost of capital. It reflects their estimated cost of equity and their cost of debt weighted for their target capital structure. Let's say it's 10%. If they can find projects that return >10% they should do the projects. If not they should return it to investors. That's Corporate Finance 101 in a few sentences.

Sure, I guess it would be stupid to for Wal-Mart to think it would see increased sales if they paid their employees, who are also Wal-Mart shoppers, more money to spend at Wal-Mart.

More money in the pockets of consumers = more demand. It's a pretty simple equation.

Walk me through the math that is going on in your head. Let's say Walmart pays its employees $100 million more. How much of that money gets spent in a Walmart? How much margin do they make on those additional sales? Is the additional margin more or less than the $100 million they have in additional expenses?

But surely there is a middle ground that would be better for the economy as a whole than returning 0% of profits back to shareholders or returning 95% of profits back to shareholders in the form of buybacks and increased dividends.

Some companies invest out of profits. Some raise equity and/or debt from investors. But ultimately cash is cash and it has an opportunity cost. This is what the weighted average cost of capital mentioned above reflects. If the project return exceeds the opportunity cost you do it. If not you don't.

So no middle ground. Ok.

Another point I don't understand. There are an infinite number of possible projects. You do the good ones. You don't do the bad ones. If you have more cash than you have good ones you send the money back. If you have more good ones than cash you go out and raise more money. When each company attempts to do this I'm sure this leads society to some middle ground.

And I am lead to believe that right now your business is doing more harm than good.

More non-sequitur. My business attempts to invest money in good projects. We attempt to avoid investing money in bad projects. If your assertion is that we would help the world more by investing money in bad projects I am inclined to disagree.

 

[Axulus]

Except this is the issue with every single product/business startup or growth. A business or a startup isn't saying, "Hey everybody has X dollars that they aren't selling, we'll sell to that" They are thinking. We are going to have to go after the dollars they are spending on the competition and they will buy our product instead.

Sure, I guess it would be stupid to for Wal-Mart to think it would see increased sales if they paid their employees, who are also Wal-Mart shoppers, more money to spend at Wal-Mart.

More money in the pockets of consumers = more demand. It's a pretty simple equation.

No it's not. Let's say that Wal-Mart gives its employees an extra $10, what percentage of that is going to come back to them? Even if their employee spends 50% of that money at Wal-Mart they are going to spending $10 to make $5. Since when is it a good business decision to spend $10 to make $5, and that's being generous.

And Wal-Mart's net margins are less than 5%. The employee spends the $5 and Wal-Mart gets $.25 profit. So they spend $10 to increase their profits by $.25. But wait - Wal-Mart gives their employees a 10% discount. Wal-Mart, if we are being generous, gets no profit, and may actually take an additional loss by paying their employees more.

 

[ksen]

I'm not saying non-sensical things like "our economy is suffering from a lack of demand".

When 500 of the most successful companies collectively decide it's better to pay out 95% of their profits for stock buybacks and dividend payments it's nonsensical to take the stance that there are no demand problems in the economy.

How are they earning a return by buying back their stock, and artificially inflating short term EPS, or sending the capital out of the corporation in the form of increased dividends? What's the typical return on dividend payments to the company paying the dividends?

This is also mostly non-sensical to me. There is nothing "artificial" about growing the EPS by having fewer S. This is the way ratios work.

Most companies have an assumption about their weighted average cost of capital. It reflects their estimated cost of equity and their cost of debt weighted for their target capital structure. Let's say it's 10%. If they can find projects that return >10% they should do the projects. If not they should return it to investors. That's Corporate Finance 101 in a few sentences.

Thanks for not even trying to answer the pretty simple question, "What's the typical return on dividend payments to the company paying the dividends?"

So if a company has an internal policy requiring 10% return on capital and they can't find anything with a return of 10%+ it's better to just return all the profits back to the shareholders instead of holding on to some or maybe bringing their standards down to 8% for a short period?

And the fact that the entire S&P 500 are having trouble finding investments that meet their criteria isn't troubling?

That their capital stock on average is the oldest it's been since around 1956 isn't a problem?

But surely there is a middle ground that would be better for the economy as a whole than returning 0% of profits back to shareholders or returning 95% of profits back to shareholders in the form of buybacks and increased dividends.

Some companies invest out of profits. Some raise equity and/or debt from investors. But ultimately cash is cash and it has an opportunity cost. This is what the weighted average cost of capital mentioned above reflects. If the project return exceeds the opportunity cost you do it. If not you don't.

What about borrowed cash? Does it make sense to borrow cash so you can pay for your buybacks and dividends?

So no middle ground. Ok.

Another point I don't understand. There are an infinite number of possible projects. You do the good ones. You don't do the bad ones. If you have more cash than you have good ones you send the money back. If you have more good ones than cash you go out and raise more money. When each company attempts to do this I'm sure this leads society to some middle ground.

That all of the companies in the S&P 500 are signaling that there are no good investments in their opinion should raise alarm bells.

And I am lead to believe that right now your business is doing more harm than good.

More non-sequitur. My business attempts to invest money in good projects. We attempt to avoid investing money in bad projects. If your assertion is that we would help the world more by investing money in bad projects I am inclined to disagree.

No, your business is to make money for your investors. Good or bad projects really has nothing to do with it. If there's a good project that won't pay off for five years and a not as good project that pays off less but a lot quicker then most investment managers will take the project that's not as good but pays off quicker.

 

[ksen]

And Wal-Mart's net margins are less than 5%.

Who cares. Their return on equity is routinely over 20%.

 

[Jayjay]

And Wal-Mart's net margins are less than 5%.

Who cares. Their return on equity is routinely over 20%.

And over 28% of the letters in "Walmart" are vowels. A statistic which, like the ROE, has nothing to do with whether spending $10 to earn $0.25 makes sense.

 

[dismal]

When 500 of the most successful companies collectively decide it's better to pay out 95% of their profits for stock buybacks and dividend payments it's nonsensical to take the stance that there are no demand problems in the economy.

OK, let's start from the beginning. How do you define "demand". How do you define "economy". How do you tell how much "demand" and "economy" has.

"What's the typical return on dividend payments to the company paying the dividends?"

I'm not avoiding the question I am not understanding it. It reads a little like "piano upside combination red pancake why?" to me. I know what the words mean individually, but don't understand the question.

And the fact that the entire S&P 500 are having trouble finding investments that meet their criteria isn't troubling?

First, the statement is not true. Some are, some are. Second, not particularly. Why should it trouble anyone?

What about borrowed cash? Does it make sense to borrow cash so you can pay for your buybacks and dividends?

It could. Debt is generally cheaper than equity. It lowers the cost of capital. Up to a point.

That all of the companies in the S&P 500 are signaling that there are no good investments in their opinion should raise alarm bells.

First, I'm not sure it does. There is a lot of capital being spent outside the S&P 500. Why does it concern you so much? I didn't think you were the sort of person that thought growing big companies bigger was the key to our prosperity.

And, if this is a big problem, how do you intend to make it more attractive for big companies to invest? Lower corporate taxes?

No, your business is to make money for your investors. Good or bad projects really has nothing to do with it.

Well, that was amusing. We more or less define a good project as one that allows us to give more money back to investors.

We're happy to wait a little longer if it means even more money. It turns out finance has invented all sorts of reasonable ways of calculating the value of cash flows over time and investors are quite attuned to it. This is what people generally are doing when they talk about returns as a percentage per year.

 

[arkirk]

Except this is the issue with every single product/business startup or growth. A business or a startup isn't saying, "Hey everybody has X dollars that they aren't selling, we'll sell to that" They are thinking. We are going to have to go after the dollars they are spending on the competition and they will buy our product instead.





No it's not. Let's say that Wal-Mart gives its employees an extra $10, what percentage of that is going to come back to them? Even if their employee spends 50% of that money at Wal-Mart they are going to spending $10 to make $5. Since when is it a good business decision to spend $10 to make $5, and that's being generous.

And Wal-Mart's net margins are less than 5%. The employee spends the $5 and Wal-Mart gets $.25 profit. So they spend $10 to increase their profits by $.25. But wait - Wal-Mart gives their employees a 10% discount. Wal-Mart, if we are being generous, gets no profit, and may actually take an additional loss by paying their employees more.

You are describing a business model that relies on welfare. That is why their business has such a huge profit. You may just be right about the 5% margin. With the boost it gets from underpaying its workers, it is able to drive smaller operations out of business. I have seen whole towns fall apart because one of the Walmart monstrosities moved in. It also got a lot of local tax relief from the town or city council just for locating there. Part of their profits are drawn from the County welfare rolls. They are unsustainable and unfair.

 

[ksen]

Retail typically has a low profit margin and relies on volume to make its money.

 

[arkirk]

Retail typically has a low profit margin and relies on volume to make its money.

Small operations can't do 5% and survive.