Companies with a balance sheet packed with cash are tempting targets for investors. But should they be?
Maybe not, says Gregory V. Milano, co-founder and CEO of Fortuna Advisors LLC. In a blog post Monday on cfo.com, the website of the trade publication CFO magazine, Mr. Milano says his firm’s research suggests cash hoarders underperform their peers.
Fortuna Advisors looked at the largest non-financial U.S.-domiciled companies that had audited financials and share-price data for the last 10 years; the list ended up with 885 names.
The average company now has 7.3 per cent of its assets in cash – nearly double the level 10 years ago, but a number now exceed 15 per cent cash, and a few topped 40 per cent.
Fortuna defined “cash hoarders” as those companies that averaged 15 per cent cash over the entire period. That list included , Amazon.com , and Celgene , to name three.
“Our research of the period from 2001 to 2010 shows that the cash hoarders deliver median total shareholder return about 4.6 per cent lower per year in comparison with the companies that hold less cash,” Mr. Milano wrote.
“Holding cash doesn’t seem to affect TSR much until it exceeds 10 per cent of assets, but then it seems to have a fairly strong negative effect once cash rises above 15 per cent of assets.”
Not all hoarders are equal, however. “Investors are willing to reward those companies that are successful in terms of high cash return on capital and high revenue growth by letting them hold cash,” Mr. Milano writes.
“The message here is that when investors think you’re likely to do something productive with the cash, they’re willing to accept your holding on to larger amounts of it. On the other hand, if you don’t deliver strong return on capital, or if you’re not growing quickly, investors become concerned about what you will do with the cash.”
Share buybacks, he adds, could be an answer. But in a separate piece of research, he says, the firm has found “three out of four companies deliver low returns on their buyback programs because they tend to buy back shares when share prices are high.”