Business Insider

Peter Crabb: Flush with cash, some companies are buying their own low-priced stock

Where has all the money gone?

We know policymakers are trying to stimulate the economy by keeping interest rates near zero and flooding the market with dollars. But businesses are leaving any cash they can make at the bank.

Earlier this month the Federal Reserve reported that for the first half of this year nonfinancial companies held about $1.85 trillion in cash and equivalents. This amount is the highest on record since the Fed began tracking corporate cash in 1952.

Many analysts attribute the corporate cash hoarding to a very weak economic outlook. Companies are reluctant to hire and invest since the economy is growing so slowly, if at all.

Some businesses do very well in bad economic times and have cash to spend. These companies are just not investing and hiring. Rather, they are returning cash to shareholders.

This doesn’t mean higher dividends. A more popular way to return cash to investors these days is the share repurchase.

Cash dividends are the periodic payments to shareholders declared by the corporation’s board of directors, normally occurring each quarter. The dividend is a regular level payment the board hopes to maintain in the future.

In contrast, a stock repurchase occurs when the company goes to the financial markets and buys its own stock directly from current shareholders. In terms of cash, a stock repurchase has the same impact of a dividend, reducing the cash balance on the books. But the economic impact of a share repurchase can be much different.

By using cash to buy up shares, the company does not make any long-term commitments to shareholders. Most directors would reluctantly vote to reduce a dividend but support a share buyback which can end anytime, often with little notice.

Further, a share repurchase has no tax consequences for existing shareholders. Cash dividends must be reported as income, but buybacks are taxable only as capital gains to those shareholders who choose to sell.

Democratic leaders in the House of Representatives announced this week that they will postpone any vote on extension of the Bush-era tax cuts until after the November elections. If these tax cuts are not extended, the tax rate on earnings from dividends will rise next year. The current rate is 15 percent for everyone but will rise to as high as 39.5 percent for high-income households.

With the pending rise in dividend tax rates, expect more firms to use cash for stock repurchases. Two big share-repurchase announcements came out this week.

Family Dollar Stores Inc. announced that current year profits are high and will beat previous estimates. Family Dollar has five stores in the Boise Valley and, in this weak economy, the stores are doing well with the many cost-conscious consumers. Over the past year the company spent $332 million buying back more than 9.4 million shares.

Walgreens, the pharmacy retailer with more than 20 stores in the Valley, is doing equally well and passing out cash to shareholders. The company reported this week a 7.4 percent increase in revenue and 11.4 percent increase in earnings. Walgreens just completed a $2 billion share repurchase with its rising cash balance.

U.S. corporations have cash to spend, the most on record. It doesn’t appear they will be using this cash anytime soon to invest in equipment or workers.

It looks to be better for companies to buy up their own cheap stock.

Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.