In the last article I argued that the growth in corporate cash balances is not as dramatic as is often reported by ana-lysts, commentators and the press.
In this post, I will show that corporate cash balances are actually growing more slowly than profitsSome quick statistics from the US Bureau of Economic Analysis: US corporate profitssince 2007 have grown at a compound annual growth rate (CAGR) of 10.58%, versus a CAGR of 8.74% for liquid assets.
By these measures, one could legitimately argue that, if anything, corporations have been draining cash from their balance sheets relative to profitabilit.
Another approach is to analyse what corporate cash balances would be today if they had grown as fast as profitability over each of the last several years. Then, a comparison of those results to the actual cash on corporate balance sheets as of the second quarter of 2011 would serve as a proxy for excesses (or deficits) of cash. (Below are the results.)
As the below data demonstrate, contrary to popular perception, corporations seem to be accumulating cash at a slower rate than profit growth.
For example, if corporate cash balances had grown at the same rate as profitssince 2007 (10.58%), then corporate cash balances at the end of the second quarter of 2011 would have been $2,170.8bn.
But instead, at the end of the second quarter 2011 cash balances were $2,047.3bn. Far from US corporations having an excess of cash, there appears to be a cash deficit.
Put another way, it appears that US corporations have an excess of cash on their balance sheets if – and only if – one ignores cash balances from 2007 to 2009, and one compares the corporate cash balance in the second quarter of 2011 with the same period in 2010.
Even then, the excess is only $24.2bn, just 1.18% above the actual cash balance – barely above 0%.So what should investors actually be concerned about?
Wth short-term interest rates at historic lows, in my view the greater concern is not whether corporations have excess cash but what corporations are earning on those cash balances, how this state of affairs is affecting the economy.
Here, the situation is more troubling.The weighted average interest rate for the US corporate liquid assets shown below is estimated to be 0.51% as of June 30, 2011. This weighted average return compares with an estimate of the core consumer price index by the Congressional Budget Officeof 1.7% for 2011.
Consequently, the net rate of return on almost $2 trillion of economic value is -1.40%.
$2 trillion of assets earning -1.40% in an economy that logged $14.527 trillion in gross domestic product and growth of 3.0% in 2010 is not trivial.
Clearly these cash balances are a drag on economic growth. But how much of a drag? This is not easy to estimate given the multiplier effect on the money supply.
However, I will attempt a very crude estimate as follows – $2,047.1bn that is losing 1.40% in value each year works out to roughly $28.66bn.
This figure compares with second quarter 2011 annualised corporate profitability of $1,514.4bn, or 1.89%
Working against that loss of economic value are the once-in-a-lifetime low interest rates at which corporations can today borrow in order to fund growth projects.
Yet that is very cold comfort to investors seeking a decent return on their assets amid this challenging environment.
Tables:
($bn) 2007 2008 2009 2010
CAGR in profits Q2 2011 10.58% 21.05% 24.54% 18.85%
What cash would be in Q2 2011 if it had grown at the same CAGR as corporate profit $2,170.8 $2,255.5 $2,324 $2,023.1
Excess (deficit) of cash $(123.5) $(208.2) $(276.7) $24.2
Source: CFA Institute