Markets & Finance

The Uses of Cash


By Joseph Lisanti Earnings of U.S. corporations are surging now after climbing out of the cellar over the past three years. S&P 500 operating earnings had peaked at 56.16 in 2000, then sank to 38.85 the following year. This year, S&P expects a record 66.43 and a further advance to 73.12 in 2005.

As a result, companies are flush with cash. At the end of September, the aggregate cash on the balance sheets of companies in the index stood at $590 billion, up 126% from the $261 billion they held at the end of 1999. We think all that excess cash augurs well for stocks.

We expect corporations to use at least some of the cash in coming months. As we see it, they have several options:

They can pay down debt. Current cash on the balance sheets of S&P 500 companies is equal to more that 38% of their long-term debt. While we don't see the cash being used to completely pay off corporate bonds (especially those low-rate instruments issued over the past few years), some repayment is likely.

They can buy back shares or increase the dividend. Either move could improve the stock's total return. Share buybacks, if not offset by shares issued in conjunction with the exercise of incentive options, can boost per-share earnings because the same profits are stretched over fewer shares. That could cause investors to bid up the company's stock.

Another use for cash is to buy another company. Merger and acquisition activity often spurs more of the same. That's generally good for the stock market because traders rush to buy shares of companies that are perceived to be potential targets.

Lastly, companies could invest in capital equipment to make operations more efficient. S&P economist Beth Ann Bovino notes that nondefense capital goods orders, excluding aircraft, surged 2.6% in September, a positive sign for business investment.

We think the deployment of corporate cash should send stocks higher in the months ahead. Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook


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