by Zach | January 15, 2014 9:30 am
Tech giant Google (GOOG) announced on January 13 that it was acquiring Internet-connected thermostat and smoke alarm maker Nest Labs for a whopping $3.2 billion in cash. Google has over $58 billion in cash and securities sitting on its balance sheet, so it can certainly afford it. But whether or not this will be a good use of shareholders’ money remains to be seen.
Businesses have several options when it comes to deploying their excess cash. They can make acquisitions like Google just did, fund organic growth, pay down debt, or return it to shareholders through dividends or stock buybacks.
Of course, a company can just let that money sit in the bank and grow its cash hoard. But with interest rates near record lows, they’re generating very low returns for their shareholders.
Ideally, a company should use its capital to maximize long-term value for their shareholders. But clearly some managers understand this concept better than others. Many corporate executives are more concerned about empire-building than producing high returns on capital and often make reckless decisions with shareholders’ money that destroys value over time.
If you own a company for the long-run, make sure you know how it is managing its cash.
It’s not uncommon for companies to distribute more and more cash to shareholders as they mature. Bigger companies have less growth opportunities and compete in crowded markets, so they plow back less of their earnings into the company and more into shareholders’ wallets. And dividends, along with stock buybacks, are the quickest and surest way to return value to shareholders.
When a company actually buys back its shares, it has a direct benefit in that it reduces the number of shares outstanding. This means that earnings are divided among fewer shares. In other words, your piece of the pie just got bigger.
If a company has the excess funds and their stock is undervalued, buybacks can add tremendous value over time. But make no mistake: stock buybacks don’t always add value. In fact, history shows that companies are often bad at timing their repurchases, buying when their share price is high.
The cash allocated to their overvalued stock would have been better spent investing for growth, paying a higher dividend, or just leaving it in the bank.
So make sure the underlying business is sound and the stock is reasonably priced before investing in a company that’s buying back its own stock. Because all the buybacks in the world won’t save a company headed off a cliff.
With that in mind, here are 4 solid, shareholder-friendly companies generating strong free cash flow, raising their dividends and buying back stock:
The Bottom Line
Companies have several options when it comes to deploying their excess cash. These 4 cash machines are choosing to return value to shareholders through generous dividends and big stock buybacks.
Todd Bunton, CFA is the Growth & Income Stock Strategist for Zacks Investment Research and Editor of the Income Plus Investor service.
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