Companies In The S&P 500: So Where Did All The Money Go?

The following article discusses Goldman Sachs Group, Inc. (GS), Bank of America Corporation (BAC), General Electric Company (GE), Ford Motor Company (F) and General Motors Corporation (GM).

From 2004 through the 3rd quarter of 2007, corporate America enjoyed one of the most robust periods of profitability ever. This should have left it in very good shape financially when the downturn occurred. However, this has not been the case. Every time you open the paper it seems like there is another company on the ropes and potentially looking for a bailout.

So where did all the money go? Well, last week Standard & Poor’s came out with their quarterly tabulation of dividends and share buybacks for S&P 500 (^GSPC) firms. It’s clear all the money went back to the shareholders in either dividends or share repurchase. Given that dividends cause a taxable event in the year they are paid — but share repurchase payouts are not triggered until the stock is sold - buybacks do have the advantage. Other than that, they are economically equivalent.

They also prevent dilution from occurring due to lavish stock option awards to executives. Further, it is common for executives to be benchmarked by compensation consultants on the basis of EPS growth and ROE [return on equity]. If you shrink the denominator, the value goes up. Share buybacks shrink shares outstanding and, unless done at less-than-book value, also shrink shareholders equity per share.

The 3rd quarter was the 6th straight quarter where cash returned to shareholders in the form of dividends and buybacks exceeded operating earnings. Since most extraordinary items are negative items (”one time” charge-offs), operating earnings almost always exceed reported earnings. Thus, the payout on reported earnings is far above 100%.

These write-offs, while not indicative of how the company fared during the quarter being reported upon, should not simply be dismissed. Generally they are the corporate world’s equivalent to Emily Latella: “Those earnings we reported last year or three years ago — NEVER MIND.” Thus over longer periods of time, the reported earnings are more realistic than the operating earnings, even if the operating earnings are a more accurate reflection of corporate health during any given reporting period.

Cash paid to shareholders, either in the form of a dividend check, or in the form of shrinking shares outstanding to help EPS grow, is not cash available to strengthen a balance sheet by paying down debt. It is cash that is not available to put into building new factories, or invest in new more efficient and productive machines. It is cash that is not available to put into R&D to develop new innovative products.

Corporations have started to pull back from their share buyback programs (now that stock prices are about 40% off their highs).  In the 3rd quarter of 2008, companies shelled out 47.8% less to buy back their own stock than they did in the 3rd quarter of 2007.  Dividends were virtually unchanged from a year ago. That is another advantage of buybacks — it is easier to cut back on them quietly than it is to cut dividends.  Still, in the 3rd quarter, buybacks alone exceeded reported earnings.

It is also noteworthy that two of the top 10 firms in total cash spent on buybacks over the last four years were Goldman Sachs (GS) which spent a total of $26.5 billion, and Bank of America (BAC) which spent a total of $25.5 billion. Both are still paying common dividends as well, even as the Federal government pours money in on extremely generous (aka “giveaway”) terms to help shore up their balance sheets.

General Electric (GE) which recently got a Federal backstop on its debt was also on the list having spent $29.6 billion over the last four years. Ford (F) and General Motors (GM) are not on the top-10 list.

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