Monday, June 9, 2014

Don’t underestimate financial engineering

“Never underestimate the ingenuity of corporate America or the optimism of its citizens.  While the media obsess over multiple economic crisis scenarios and reinforce the message that the economy promises little growth, corporations just keep on grinding out higher earnings.…

“Pressured on the top line, corporations have been cutting costs, downsizing and increasing worker productivity since 2008.  This obviously has its limits and becomes less effective over time, but greater efficiency is a mind-set that takes year to instill in large organizations before measurable saving occur.

“Since markets care more about earnings per share than total earnings, financial engineering is an effective tool that can work wonders.  With interest rates so low, and shrinking sales requiring less working capital, corporations can borrow cheaply and leverage their balance sheets to use the increased cash flow to buy back outstanding shares.  Some 20% of all U.S. corporate stock has thus been bought back since 2005.  Another tool is growth through mergers and acquisitions.  Resurgent stock prices and huge buildups of cash make buying other companies with lower price/earnings ratios an attractive option.  It’s also a way to use overseas cash for foreign buyouts without first having it taxed in the U.S.  Upwards of $600 billion in deals so far this year testifies to the popularity of this trend.”  [Richard Lehmann, Forbes, June 16]