Practical analysis for investment professionals
23 November 2011

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:

…2007 …2008 …2009 …2010
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
$2,170.8 $2,255.5 $2,324.0 $2,023.1
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

Return
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%
Commercial paper 0.15%
Treasury securities 0.10%
Agency and GSE-backed securities 3.56%
Municipal securities and loans 4.59%
Mutual fund shares 0.00%
 
Weighted average = 0.30%*
 

Sources: The Federal Reserve, ConsumerismCommentary.com, DWS Investments, eFannieMae.com, CFA Institute, Bank of America, Merrill-Lynch.


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.

About the Author(s)
Jason Voss, CFA

Jason Voss, CFA, tirelessly focuses on improving the ability of investors to better serve end clients. He is the author of the Foreword Reviews Business Book of the Year Finalist, The Intuitive Investor and the CEO of Active Investment Management (AIM) Consulting. Previously, he was a portfolio manager at Davis Selected Advisers, L.P., where he co-managed the Davis Appreciation and Income Fund to noteworthy returns. Voss holds a BA in economics and an MBA in finance and accounting from the University of Colorado.

Ethics Statement

My statement of ethics is very simple, really: I treat others as I would like to be treated. In my opinion, all systems of ethics distill to this simple statement. If you believe I have deviated from this standard, I would love to hear from you: jason@jasonapollovoss.com

4 thoughts on “The Mountain of Corporate Cash (Part 2): Cash Balances vs. Profits”

  1. Ryan T. Kipp says:

    Jason,

    This is a very interesting analysis you’ve put together. The results are contrary to the common perception today that corporate cash is growing at a disporportionate rate. I work for a major bank focusing on money market instruments and this data refutes a common industry perception. However, one data point from the analysis looks inaccurate – “checkable deposits and currency of 1.00%” seems very high, especially when you consider 1 month Libor has been trending around 0.25%. I’d be interesting in discussing further if you want to email me.

  2. James Mawson says:

    Really interesting work, Jason.
    I saw your blog on FTfm and wanted to see if i could also share this two-parter with my Global Corporate Venturing readers (people at corporations trying to get a higher return with strategic value) via a link and attribution to you?
    cheers, Jim

  3. Hi Ryan,
    Thanks very much for your comment. Indeed, your trenchant eye caught one of the pieces of data that I was having difficulty tracking down. To be conservative, I took the highest yield figure I could find for checkable deposits. Based on your suggested source for checkable deposits yield data, the post will be updated imminently.

    With smiles!

    Jason A. Voss, CFA

  4. John Burkit says:

    Jason,

    Great article with very interesting insights, especially considering the common perception on current corporate cash growth levels. I was wondering how accurate you think the comparison is for companies with significantly high or low ratios of cash balances to profits. In such cases, using profit growth percentages to parallel cash growth is somewhat misleading and will need to be supplemented with a reference to absolutes (i.e. profit dollars). Would love to hear your thoughts. Please feel free to e-mail.

    Best,
    John

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