After five interest-rate cuts by the Federal Reserve, policymakers and investors impatiently wonder why they're not seeing an iota of revival in the corporate capital spending that once powered the economy and bull market. The roadblock may well be within the stock market itself. Look closely, and you'll see that a powerful body of shareholders are telling corporations to boost payouts for share buybacks and dividends before spending more on new technology.
"We had such robustness in capital spending, that now the investment community is voting with their feet and saying, `Rein it in,"' says Steve Galbraith, stock strategist at Morgan Stanley Dean Witter & Co. The evidence: Companies that reduced shares outstanding through share buybacks saw their stocks, on average, beat the return of the 1,000 largest stocks on U.S. exchanges (as measured by the Russell 1000 index) in 2000 by 12.5 percentage points. They maintained their lead through April, the latest data available, marking a dramatic reversal from 1999. Then investors bid up the stock prices of companies that plowed every dollar into projects to accelerate earnings growth. The stocks of companies shrinking their share counts lagged by 28 percentage points in 1999. And as the accompanying table shows, many companies that combined big share repurchases and high dividends have seen their stocks do even better.
CONVERTIBLES, TOO. Dividends, the traditional tool for distributing profits to shareholders, command new respect from investors for the first time in years. High-dividend-yield stocks, such as utilities, oil companies, and real estate investment trusts, have been the best performers since last year's tech-stock bust, notes Richard E. Cripps, market strategist at Legg Mason Inc. His firm interviewed its investors after the market downturn and found many craving steady payouts. The sentiment, he says, is also reflected by recent record sales of convertible securities, which pay interest but can be exchanged for stock. Says Galbraith: "We have returned to a market where cash returns are king."
That sounds like hyperbole to some. Edward P. Hemmelgarn, chief investment officer at Shaker Investments Inc., doubts investors' stock preferences have really changed all that much. A lot of the decline in stocks of companies that pour cash into growth was merely the result of investors trying to trade out of those stocks before they fell further, he says. Investors always shift toward the safety of more bond-like investments when the economy and stocks falter, adds James W. Paulsen, chief investment officer at Wells Capital Management.
But this time the new attitude toward buybacks and dividends may last for a long while, even if the stock market rises gradually from here. "Companies may opt to pay out more of their earnings" through buybacks and dividends because they don't have anything better to do with the money, says Paulsen.
NEW ANTAGONISM. Several factors are holding down returns on corporate investment: high energy costs, price pressure from competitors, and, most important, the recent passage of a long-running capital investment boom. That boom already snared the best profit opportunities and productivity gains. Richard Jandrain, chief equity investment officer at Banc One Investment Advisors, says institutional investors now expect managements to justify spending on technology, a switch from the recent past when tech spending was assumed to be worthwhile, if not essential. Richard Hoey, chief economist at Dreyfus Corp., says the past year brought new antagonism between investors and managers over allocation of capital.
Now there are signs that the friction is giving way to agreement between managers and investors that more capital spending should be deferred. Tobias Levkovich, stock strategist at Salomon Smith Barney, says a financial-services company manager recently described how he could lift this year's profit margins by deferring planned capital spending on technology. Levkovich took the cue, checked financial reports from a range of companies, and concluded that, on average, companies can boost profits by 1% to 2% by cutting information-technology spending by 10%. The potential savings comes from avoiding the rapid depreciation charges and one-time cost of software and employee training that come with the new equipment. That may not sound like much of a savings, but it is a lot when companies are struggling to meet earnings estimates.
For investors, the message is not to rush back to the tech stocks that depend on growing capital spending. Instead, they should continue to favor companies whose returns through dividends and stock buybacks are more certain. If more investors follow that advice, companies will have a stronger incentive to forgo expensive tech projects. And that would delay the capital spending bounce-back even longer.
By David Henry in New York