Blackrock (BLK) CEO Laurence Fink, whose company is the world’s largest money manager with $4.3 trillion in assets under administration, has called shenanigans on the nation’s biggest corporate leaders.
In a letter last month, Fink warns the leaders of S&P 500 companies that their short-term thinking is detrimental to sustainable long-term returns, which affects shareholders of all sizes.
The economy — most especially the jobs market — has been seriously stunted by the diversion of corporate funds from long-term capital investment to share repurchases and increased dividends. It might look good to investors, but in the end, it’s really just smoke and mirrors.
Fink advocates the use of patient capital, which includes investments in capital and plant equipment, product development, research and development as well as employee development.
Short-term thinking by CEOs is a Wall Street cancer, and for the sake of the nation, it needs to be stamped out — immediately.
Record Share Repurchases
S&P 500 companies spent $475.6 billion repurchasing their shares in 2013 — 19% higher than a year earlier, and an average of almost $1 billion per company.
Interestingly, the 19% increase was equal to the average daily stock price increase, meaning share repurchases barely kept up with market price. This suggests CEOs overpaid for their stock in 2013.
Regardless of whether you agree with my assessment, you should be concerned by the amount of money shelled out for this short-term bump in earnings per share. Especially when you consider that CEOs are destroying this shareholder value through dilutive equity awards to management. In many cases, the gains from share repurchases are nullified by excessive executive compensation. It’s poor capital allocation over any length of time.
Capital allocation has become a serious hot-button issue among large institutional investors. People like Fink believe that CEOs who fail to invest in their businesses aren’t doing their jobs effectively. Others, like activist investor Carl Icahn, believe that incumbent management is incompetent in many cases. In those situations, Icahn believes share repurchases and dividends are much safer options than deploying capital into poorly thought out or executed investments.
Basic opinions aside, I think both would agree that corporate nirvana exists when capex is strong and growth is prevalent. That can’t be achieved with short-term thinking.
Carl Icahn’s original demand from Apple (AAPL) was that it repurchase $150 billion of its stock using a combination of cash and debt to fund the buyback. That got watered down to $50 billion by the end of last September, and Icahn dropped his demands in February after Apple announced it had repurchased more than $40 billion of its stock during the past year.
Activist investors like Icahn are interested in extracting as much shareholder value as possible. You can’t blame them for doing whatever it takes to maximize their investment. However, when it involves adding debt while sacrificing capital expenditures, we’re talking about destabilizing the balance sheet to provide short-term shareholder relief.
Consumers are always chided about not living within our means, yet here was Icahn telling Tim Cook to sell a bunch of bonds so he could get a bigger chunk of Apple’s earnings.
Under no circumstances should a company add debt to pay out dividends or repurchase shares. That’s precisely what Apple did last April when it issued $3 billion of floating-rate notes and $14 billion of fixed-rate securities as part of its $100 billion capital reward for shareholders.
Apple had no debt at the time, making the $17-billion raise a non-issue when it comes to its balance sheet. However, a bigger concern is that the debt raised lowered the amount of cash it would have to repatriate from overseas, reducing the taxes paid to the federal government.
In essence, AAPL leveraged itself to avoid paying taxes here in America that help pay for infrastructure.
That’s short-term thinking at its worst because not only does it weaken the balance sheet ever so slightly, but it also sacrifices the quality of life for Americans — rich or poor.
A Different Approach
When Laurence Fink was writing his letter to the CEOs of the S&P 500, he likely was thinking about Warren Buffett, whose Berkshire Hathaway (BRK.B) is the ultimate example of a company generating sustainable long-term returns.
In the past three years, Buffett’s operating businesses have made capital expenditures totaling $29.1 billion. At the same time, they have spent exactly $1.3 billion on share repurchases and dividends. In the past decade, it has increased capital expenditures by 27% on a yearly basis to $11.1 billion at the end of 2013. Meanwhile, pretax earnings of those operating businesses have grown 12% annually over the 10-year period compared to 7.8% annualized growth for its stock.
What do all those numbers tell us?
Well, first, it tells us that Berkshire Hathaway’s stock hasn’t been growing nearly as fast as its earnings over the past decade. Secondly, we know that the company generates approximately $2 in operating earnings for every $1 in capital expenditures.
The markets simply aren’t reflecting the true earnings power of BRK.A/BRK.B. Eventually, this will change.
Meanwhile, Exxon Mobil (XOM) spent $59 billion over the past three years buying back stock. It generates about the same amount of operating earnings per dollar in capital expenditures. Over the past decade, XOM has achieved an annualized total return of 11.9% through the end of 2013 — 410 basis points greater than Berkshire Hathaway.
That’s pretty good. But consider that Exxon Mobil continues to struggle with oil and gas production. It’s getting harder to find big oil reserves. By allocating $59 billion to share repurchases rather than finding new reserves, the company is sacrificing long-term sustainable returns for short-term gains in its stock price.
Eventually, this will come back to bite Exxon in the you-know-where.
Laurence Fink thinks this sort of short-term thinking has to stop. I couldn’t agree more. America can’t share-buyback itself out of a weak economy.
Only jobs and capital spending will do that.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.