Corporate Profits: Spend Them Wisely

Corporate profits have been on a tear. Earnings for the 900 companies on BusinessWeek's Corporate Scoreboard rose 25% in the fourth quarter of 2004, far surpassing earlier estimates. Last year was the first time profits rose above their boomtime peak in 2000. Companies are flush with nearly $1 trillion in cash, and they are itching to put it to work.

For some, maybe too itchy. Chief executives are choosing between raising dividends or doing deals, and history shows that the stock market rewards dividend givers and punishes most dealmakers. While the current wave of deals is a welcome boost for Corporate America, CEOs should be wary. In the 20 largest deals since 1995, the average combined company underperformed the market by nearly 13%.

Judging by the record amount of dividends paid out last year, most CEOs know their history. Standard & Poor's (MHP ) estimates that cash dividends will set another record in 2005: up 12%, to $203 billion, from $181 billion in 2004. Chief execs are also using more of their cash flow to finance capital spending, which was up 18% for the fourth quarter and 9% for the year. It shows few signs of slowing down.

And, of course, a growing number of CEOs are doing deals. So far, many make sense. Companies are paying modest premiums, bolstering their core businesses, building scale, and integrating new operations carefully. But some deals appear problematic. It's good that profits are piling up. It's even better to use them wisely.

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