The Corporate Cash Hoarding Syndrome

Includes: AAPL, GOOG
by: Disruptive Investor

According to The Federal Reserve Bank of St. Louis publication of January 2013, the U.S. corporate sector has a cash hoarding of nearly $5 trillion as of 2011. This article discusses the reasons for the U.S. corporate sector hoarding cash and its impact on the economy.

It is a good time to discuss this issue as Apple (NASDAQ:AAPL) finds itself in the center of attention from lawmakers with nearly $102 billion of cash holdings outside the United States. The lawmakers have accused Apple of avoiding tax of nearly $35 billion by holding the cash outside the country. I mention this specific case because tax policies in the United States have played a large role in the recent years in determining where companies hold their cash.

Coming to the broader picture, the chart below gives the aggregate cash and cash equivalent of U.S. firms from 1980 to 2011.

There has been a gradual increase in cash hoarding by the corporate sector over the last three decades. However, the cash hoarding has increased in the recent years. This can be explained by the current economic scenario in the United States and globally. As economic growth remains uncertain, the corporate sector is less willing to invest in high-value projects. The U.S. government policies have also played a major role in the way the corporate sector has been hoarding cash. There needs to be more clarity on the long-term direction of taxes before the corporate sector starts investing the money in the United States. Therefore, sluggish economic growth and policy uncertainty are the two biggest reasons for increased cash hoarding by firms.

Readers might point to the fact that the corporate sector in the United States has grown by leaps and bounds in the last three decades. It would therefore be natural to see an increase in cash in line with an overall balance sheet expansion. I would like to use the ratio of cash to net assets in order to prove the point that cash holdings have increased significantly over the last few years. The ratio of cash to net assets has increased from nearly 0.05 in the 1990s to over 0.12 as of 2011. In particular, the surge after the financial crisis is noticeable in the chart below.

Another important reason for the high amount of cash hoarding is the high repatriation tax, which serves as a deterrent for the corporate sector to bring back cash to the United States. According to an article on Forbes -

In 2012, U.S. non-financial companies filled their coffers with an additional $130 billion, taking their total cash to a record $1.45 trillion as the economy has stagnated and the labor market has moved sideways. At the same time, prohibitive corporate tax schemes coupled with emerging market growth have pushed U.S. firms to keep 58% of their cash, or $840 billion, overseas.

The point on emerging market growth is also very valid as corporations are investing in markets where they can derive a higher return on investment. Asia, Emerging Europe and Emerging Africa are the more attractive destinations for investment than the advanced economies.

The publication [pdf] by The Federal Reserve Bank of St. Louis provides another important reason for cash hoarding by the corporate sector. However, this is more sector-specific and might not explain an overall increase in cash levels. As the chart below shows, the cash level is relatively higher for R&D intensive industries such as the pharmaceutical sector and the IT sector. As mentioned earlier, this is more sector-specific and does not provide an explanation for the overall trend. The economic growth factor and the government policy factor are the biggest reasons for an increase in corporate cash hoarding.

From an investment perspective, investors can expect higher dividends and attractive share repurchase as the cash holdings swell in some big companies. Therefore, it is a good idea to have some stocks, which have a high cash and cash equivalent in the portfolio.

I would personally recommend the IT sector giants and more importantly, innovation driven companies for exposure on market correction over the next 3-6 months. In particular, investors should consider having one of the two companies listed below in their portfolio.

Apple Inc. - Can be considered to be a relatively good dividend investment option more than a growth stock option. The stock is currently trading at an attractive P/E of 10.6 with a dividend yield of 2.8%, which will improve over the next quarters. Also, with the next line of products to be rolled out in autumn 2013, and in 2014, the stock might consolidate at current levels before the next significant move on product announcement and the market response. Going forward, share buybacks by the IT giant can also spur prices higher besides regular dividend income.

Google Inc. (NASDAQ:GOOG) - The search engine giant is a good stock to buy on any correction and has a growing cash holding in its coffers. As it has been in the past, innovation will drive growth for GOOG more than its industry peers. The release of Google Glass will be just another breakthrough product from Google. It might still be too early to assess the impact of Google Glass on the company's revenue. However, the market might be significant, according to IMS research. GOOG is currently trading at a relatively attractive five-year expected PEG ratio of 1.27. Any stock-specific correction will be a great buy opportunity, in my opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.