Capex and the surprising way to identify U.S. stock winners

Flush with cash, but too cautious to reinvest – that's how corporate America is commonly characterized these days. That perception isn't exactly supported by market evidence, according to a new Barclays report.

In fact, capital expenditures among S&P 500 companies hit a record high in 2014. But the surge in capex has not been good to investors.

"Despite the record amount being spent on capex, the market has not been rewarding companies for this type of cash use," said Jonathan Glionna, Barclays' head of U.S. equity strategy. "The stocks of companies that invested a large portion of cash flow in capital expenditures performed significantly worse than companies that instead returned capital to shareholders through buybacks."

In other words, it is investors, not executives, who are averse to capex. The clear lesson for investors is to screen for stocks with a low proportion of capital expenditures relative to share repurchases.

"It may seem unjust that the equities of companies that make long-term capital investments in their businesses perform worse than the equities of companies that buy back their shares. But the data shows it is the case," Mr. Glionna said.

Though the years since the recession have been turbulent economically, high and rising corporate profits have consistently pierced through the volatility.

Ever increasing margins have filled corporate coffers, while shareholders have pressured stockpiling companies to put excess cash to use.

A common narrative has emerged that corporations are unwilling to deploy that cash in any risky way, preferring the safe and noncommittal option of buying back shares.

Buybacks have indeed skyrocketed, but not to the detriment of capital expenditures, which rose to $730-billion (U.S.) in 2014, representing "a 25-per-cent increase from the prior cycle peak and a new all-time record," Mr. Glionna said.

Over the last 12 months, companies in the index deployed $1.9-trillion of cash, with about 40 per cent of that total going toward capex, Barclays estimated.

The second highest use of cash was buybacks at about 30 per cent, followed by dividends at 19 per cent, and acquisitions at 12 per cent.

Among the first three sources of cash, heavy investors in capex produced the lowest stock gains over the last five years, trailing prominent stock repurchasers by about 5 per cent in cumulative spread returns. Dividend stocks were the most lucrative, but performance peaked in mid-2012 and cumulative returns since then have been negative, Mr. Glionna said.

"When it comes to performance in the market, the stocks of companies that spend less on capex remain clear winners," he said, noting that he does "not see this trend changing."

Barclays included a list of 18 stocks – two from each sector of the S&P 500 – which have low ratios of capital expenditures to net share repurchases.