The Mountain of Corporate Cash (Part 2): Cash Balances vs. Profits
In part one of “Is the Mountain of Corporate Cash an Illusion?” I argued that the growth in corporate cash balances is not as dramatic as is often reported by analysts, commentators, and the press. In this post, I’ll show that corporate cash balances are actually growing more slowly than profits.
Some quick statistics from the U.S. Bureau of Economic Analysis: U.S. corporate profits since 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’ cash balances have been dropping relative to profitability.
Another approach is to analyze what corporate cash balances would be today if they had grown as fast as profitability has over each of the last several years. Then, a comparison of those results to the actual cash on corporate balance sheets as of second quarter 2011 would serve as a proxy for excesses (or deficits) of cash.
Here are the results:
|CAGR in profits 2Q 2011 versus…||10.58%||21.05%||24.54%||18.85%|
|What cash would be in 2Q 2011 if it had grown at the same CAGR as corporate profits
|Excess (or deficit) of cash as compared to actual liquid assets of $2,047.3||($123.5)||($208.2)||($276.7)||$24.2|
Source: CFA Institute.
As the above 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 profits since 2007 (i.e., 10.58%), then corporate cash balances at the end of the second quarter 2011 would have been $2,170.8 billion. Instead, at the end of the second quarter 2011, cash balances were $2,047.3 billion. Far from U.S. corporations having an excess of cash, there in fact appears to be a cash deficit.
Put another way, it appears that U.S. corporations have an excess of cash on their balance sheets if — and only if — you: (1) ignore cash balances from 2007 to 2009; and (2) compare the corporate cash balance in the second quarter of 2011 to those in 2010. Even then, any cash considered “excess” is only $24.2 billion, which is just 1.18% above the actual cash balance of $2,047.3 billion (i.e., barely above zero percent).
So what should investors actually be concerned about?
With short-term interest rates at historic lows, the greater concern is not, “Do corporations have excess cash?” but rather, “What are corporations earning on those cash balances?” And, how is this state of affairs affecting the economy?
Here, the situation is more troubling.
The weighted average interest rate for the U.S. corporate liquid assets (shown below) is estimated at 0.30% as of 30 June 2011.* Compare this weighted average return to an estimated core consumer price index of 1.7% for 2011. Consequently, the net rate of return on almost $2,000 billion of economic value is –1.40%!*
Interest Rates Paid on Various Short Duration Assets 2Q 2011
|Private foreign deposits||0.52%|
|Checkable deposits and currency||0.25%*|
|Total time and savings deposits||0.32%|
|Money market mutual fund shares||0.06%|
|Federal funds and security repurchase agreements||0.09%|
|Agency and GSE-backed securities||3.56%|
|Municipal securities and loans||4.59%|
|Mutual fund shares||0.00%|
|Weighted average =||0.30%*|
Two trillion dollars worth of assets earning –1.40%* is not trivial, especially in an economy that logged $14,527 billion in gross domestic product and growth of only 3.0% in 2010.
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. I’ll attempt, however, a very crude estimate: $2,047.3 billion that is losing 1.40%* in value each year works out to roughly $28.66* billion. Compare this figure to second quarter 2011 annualized corporate profitability of $1,514.4 billion, or 1.89%* (U.S. Bureau of Economic Analysis).
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 in this challenging environment.
* Figures with asterisks were updated on 28 November 2011 to reflect more accurate data provided by a reader. For more context, see the comments below this article.