Invest in Companies that Don’t Invest

This sounds counterintuitive, but research shows that stocks of companies that don’t invest perform better.

Eugene Fama, winner of the economics Nobel, and his colleague Ken French, have expanded their famous “three-factor” model to include corporate investment as a driver of returns, alongside value, momentum and size (they also added profitability). Broadly speaking, companies which invest more tend to underperform those which spend little. But, as with the other factors, it may take years to profit from such an approach.

A plausible case can be made that the corporate caution induced by the 2008 financial crisis contributed to the wonderful returns made by shareholders in its aftermath. Companies were reluctant to invest despite elevated profit margins, instead returning spare cash via share buybacks. With the triple tailwinds of a low starting valuation, easy money and little wage pressure, margins remained high and stocks prospered.

All three of the tailwinds are now in question, and U.S. companies are investing more (outside the energy sector, the one place where money poured in, only to be poured into holes in the ground). Shareholders are also encouraging corporate capital spending: according to a regular Bank of America Merrill Lynch survey of fund managers, the clamor for U.S. companies to invest spare cash rather than pay it out is at record levels.

Posted by on May 24th, 2016 at 7:09 am


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