While many people are still scraping to make ends meet in a jobless recovery, corporate America is rolling in cash.
By scrimping on hiring and costs even as business picked up, U.S. companies have stockpiled nearly $2 trillion. All that money is beginning to make investors -- and in turn, top executives -- nervous.
After all, a rule of thumb is that if you leave managers with too much cash lying around, they're liable to blow it on something dumb -- such as ego-building acquisitions that do little for shareholders. And keeping too much money in cash, which might earn less than 1% a year, can drag down performance yardsticks and a stock's price.
Investors -- and politicians -- have started to apply pressure on executives to do something with that cash. That pressure will only grow, and it's having an impact. Share buybacks are up sharply, for example. The unleashing of all this cash, in fact, could be the big business story of 2011 and beyond.
3 trends in the making
This unleashing would create three clear opportunities for investors:- B2B. Business-to-business, or B2B, companies -- those that primarily sell things to other businesses -- will see big payoffs as companies increase capital spending. The shares of smaller B2B companies may do particularly well because they are relatively unnoticed. Three potential winners are Faro Technologies (FARO, news, msgs), which sells precision measurement tools; Titan Machinery (TITN, news, msgs), which sells farming and construction equipment; and GrafTech International (GTI, news, msgs), which sells electrodes used in steel production.
- Rising dividends. Companies likely to use the money to raise dividends look attractive, especially when they are reasonably valued. Strong candidates here are agricultural giant Archer Daniels Midland (ADM, news, msgs), drug-maker Bristol-Myers Squibb (BMY, news, msgs) and discount retailer TJX (TJX, news, msgs).
- Big share buybacks. The shares of companies deploying cash to buy back large amounts of stock should also see strength, since fewer shares in the market tends to increase the value of those still out there. It's also a sign that top managers see value in their stocks. Potential winners here include clothing giant Gap (GPS, news, msgs), airline company SkyWest (SKYW, news, msgs) and cut-rate retailer Dollar Tree (DLTR, news, msgs).
To locate the stocks above, I talked with three investment experts who have consistent records of beating the markets. So I'm pretty confident the nine stocks above have a good shot at outperforming, too. My brain trust here was a co-portfolio manager of Hodges Small Cap Fund (HDPSX), the editor of a dividend newsletter called Investment Quality Trends and the president of Fried Asset Management, which picks stocks in part by looking at buyback trends.
I'll have more on these companies later, but first a deeper look at this cash-rich trend:
Time to cut the blubber
Corporate scrimping has sent annual operating cash flow at companies back up to peak levels, or more than $1 trillion. Capital spending is still down sharply from 2008 peaks, and managers aren't hiring a lot, so the money is piling up."Companies have been very cautious even though they are very profitable," says Mark Zandi, the chief economist and a co-founder of Moody's Analytics. "It's showing up as cash on balance sheets."
Cash at nonfinancial companies stands at $1.84 trillion, or nearly 13% of gross domestic product. That's up from $1.43 billion at the end of 2008. And it's a 70-year peak.
Saving money made sense during the scary days of the credit crunch, when many businesses had problems because credit lines dried up. No CEO wants to go through that again. But now that it seems like the economy will at least stay in slow-growth mode, there's growing pressure from investors on companies to deploy cash that's producing virtually no return for shareholders.
"I've heard a lot of questions being put to management saying, 'OK, you've been sitting on a ridiculous amount of cash for two or three years. We understand that has taken risk out of your business. But now what?'" says Eric Marshall, a co-portfolio manager of the Hodges Small Cap Fund. "If investors want to sit on cash, they can have cash in their portfolios."
Here's another way to put it: Cash is like blubber on a seal. It protects the animal during a harsh winter but is bothersome in spring and summer, says Mark Flannery, Credit Suisse Group's U.S. director of research. "We believe that U.S. companies are now ending their recent enforced hibernation. Survival mode is over. . . . Now it's time to cash out."
So look for cash to be put to work in three obvious ways.
1. B2B is back
Consumer spending is growing at a relatively sluggish 2% to 3% a year, but capital spending by companies was up 21% in the second quarter of 2010. And growth is likely to continue to remain robust for a while, given how long companies have held off on upgrading plants, equipment and computer systems."We see this trend continuing over the medium term," says Deutsche Bank chief strategist Binky Chadha. Besides pressure from investors, capital spending just looks way too low, compared with how much the economy has come back, Chadha says. The upshot: "Even in a low-overall-growth environment, firms exposed to the higher business spending cycle should outperform," he says.
Marshall, of the Hodges Small Cap Fund -- which is up 28% in the past year, or 13 percentage points more than the average small cap fund -- thinks companies selling things that improve productivity will do particularly well in a slow-growth environment.
"As capital spending budgets come unlocked, companies are going to deploy their capital into technology that will make them more efficient," he says. "Given the outlook for slower growth, everyone is focused on becoming efficient with what they have."
Continued: 3 businesses that should benefit
