Marty Whitman: How Cash Can Be Used Most Productively by Corporations
This quarter, I thought it might be of interest to my fellow shareholders to expand upon our thoughts on how cash can be most productively used by corporations. Corporate Uses of Cash
In the broadest context, a corporation has only three uses of cash: 1) Expand assets 2) Reduce liabilities 3) Make distributions to shareholders a) Pay dividends b) Repurchase outstanding equity securities
However, for most companies it is highly impractical to plan to raise new equity capital by making periodic trips to capital markets. These markets are notoriously capricious. At times, access to equity markets can be had on a super attractive basis – see the 1999 dot com bubble. At other times, there can be no access at all to equity markets at any price – see the 2008-2009 meltdown. In any event, raising new equity by accessing capital markets tends to be quite expensive; gross spreads range between, say, 21⁄2% and 7%. Rather, the vast majority of corporations will continue to get most of their new equity capital (and cash) through retained earnings, i.e., profits not distributed to shareholders.
From a management point of view, share repurchases are a simpler use of funds than expanding the asset base most of the time simply because the research task is so much easier. You are less likely to make analytic mistakes when involved with your own enterprise, rather than an enterprise controlled and managed by someone else.
From a shareholders' point of view, especially the point of view of shareholders affected by daily stock price fluctuations, there are important advantages to these shareholders if cash distributions to shareholders are made in the form of dividends rather than stock buy backs. First, the markets populated by outside passive minority investors ("OPMIs") are volatile. However, insofar as a company pays regular dividends which are increased periodically market prices tend to be a lot less capricious than would otherwise be the case because the shares tend to get priced, at least in part, on a return (or yield) basis. Second, many OPMIs rely on regular dividend payments to meet living expenses.
Read the complete commentary. Start from page 5.