08/19/2011 05:44 EDT | Updated 10/19/2011 05:12 EDT

Putting Cash to Work


The same culprits that came out of the woodwork last summer to predict impending recession are back at it. The amount of airtime being given to these folks, after they so missed the call last year, is amazing.

I was stopped by a business owner on the street who had just read the latest edition of one of Canada's noteworthy news magazines and was visibly upset -- not by the dark prognostications, but because of how negatively biased it was. I suggested it might make good lining for a bird cage.

One of the reasons I have been loath to join the doom-and-gloom crowd in recent weeks has been the state of corporate finances in North America. We have just come off multiple quarters of strong earnings performance, leading to bloated cash balances among firms. In the U.S. alone, the cash hoard is close to two trillion dollars and climbing. Canadian firms are enjoying decent profit growth as well, although the drag from the lofty Loonie is being felt. Bottom line, this latest go round of negativity has nothing to do with a lack of earnings or liquidity, as we dealt with in 2008. Quite the opposite in fact.

This is all about waiting for firms to open the taps and start using their burgeoning sacks of cash. Similar to households, companies are more likely to build cash positions when there is economic uncertainty. This makes the difference between a firm staying afloat and getting capsized by a rogue recession wave.

Politicians on both sides of the pond, in their bungling of fiscal affairs, have caused the uncertainty that has prompted firms to build cash; however, smart CEOs will recognize that there is a limit to political ineptitude and that the tough fiscal decisions will inevitably have to be made. This realization will be one catalyst for spending cash, whether it's in the form of increased hiring, expanded capital investment, mergers and acquisition, raising dividends or simply buying back stock. The latter two will become particularly important in my opinion this half.

After seeing $6 trillion dollars of equity market valuation wiped out from the mess of the past several weeks, investors are understandably peeved. Retirement plans are being brought into question because of the decline in equity assets and severely depressed yields on fixed income paper. Investors know that companies have no control over the interest rates they are getting on their 'safer' securities (other than running a strong business and having a solid credit rating), but they can do something about yield on common stock. The longer firms resist the temptation to put earnings to work in expanding operations, the louder the call will be for dividend increases as compensation for the perceived added risk in holding stock in this environment. I would expect the call for share buybacks to also get even louder, particularly for those companies that either don't pay dividends or are on the low end of the dividend scale.

Since the start of this quarter, only 23 companies on the S&P 500 have announced share buybacks, according to Bloomberg statistics. This compares with 47 firms in the second quarter and 48 buybacks during the same period a year ago. While there is no guarantee that an increase in share buybacks will turn the bearish market around, it could protect against further significant (negative) technical milestones. That said, the more positive deployment of cash would be towards operations and not dividends or buybacks.

If uncertainty regarding the political ability to stabilize US and European fiscal situations proves transient, and firms start to look at increasing capital spending and beefing up payrolls, it becomes a win-win. Share valuations will be enhanced, but future revenue and profit growth will as well, providing for a stronger basis for dividend growth than simply the paying out of nervous cash hoards.