Companies that make so much money that they're rich with cash have something on the ball — because they made it. And lots of cash on hand naturally provides a safety net of sorts for shareholders. But generally, a great deal of excess cash can crimp shareholders' return on equity — a measure of what the company gives shareholders back on the money they've invested.
Companies that continue to accumulate excess cash can be viewed as lacking ideas for investment in the enterprise. Isn't there something these companies can do with the money to boost revenues, profits and earnings for shareholders?
Research shows that having too much cash on hand is almost as bad as having too little when it comes to auguring future returns to shareholders. Studying major companies with large amounts of cash between 2001 and 2016, Revelation Investment Research found that this foreshadowed poor returns the following year. The more cash, the lower the returns — into negative territory.
The returns of the biggest cash hoarders were almost as poor as those of companies studied that had the least cash on hand, whose poor performance was understandable because they likely lacked enough cash to take advantage of opportunities. The researchers suggested that the market punished the underperformers for "poor capital allocation or utilization." Consistent with the lesson of Goldilocks and the Three Bears, companies with relatively moderate amounts of cash registered the best market performance.
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Another study, conducted at the University of Toronto, found that companies with high levels of excess cash have tended to deliver lower market returns during market downturns. And even though the higher-cash companies invested more in their future, they didn't experience relatively high future profitability. Based on this finding, could it be that having too much cash lying around leads to less judicious decisions about how to invest in the company?
Further, a common trap for companies that have too much cash burning holes in their pockets may be more inclined to engage in share buybacks — a practice that can raise questions for shareholders.
Romantic poet William Blake wrote in the late 18th century that "one law for the lion and the ox is oppression." Applying Blake's logic, judging different kinds of cash-rich companies the same way probably doesn't make sense.
Tech companies tend to accumulate more cash because, as producers of high-margin products based on intellectual property, they don't have the same materials costs as non-tech manufacturers.