DEPLETING CASH RESERVES:
Companies have been blowing their cash reserves. Meta’s reserves have declined from $64 billion
down to $37 billion, a decrease of 42%. Google’s reserves have declined from $142
billion down to $115 billion, a decrease of 19% Microsoft’s reserves have declined from
$136 billion down to $104 billion, a decrease of 23%. And Apple’s reserves have declined from
$107 billion down to $51 billion, a decrease of 52%. This isn’t some sort of random fluctuation
either. For the past decade, all of these companies
had been vigorously increasing their cash reserves until the past 12 to 24 months. With such massive decreases in cash reserves,
you would think that these companies have been furiously paying off their debt, but
that’s not the case either. Apple, for example, has maintained their long
term debt at right around a $100 billion. Google and Meta on the other hand have even
gone as far as increasing their debt. Google has increased their long term debt
by over 200% from $4 billion to $14 billion. Meta on the other hand is holding debt for
virtually the first time in the company’s history. This makes no sense at all. These companies were hoarding cash in the
tens of billions if not hundreds of billions when interest rates were low. So, with such high interest rates, you would
think that they would just double down on their cash reserves and pay off debt as quickly
as possible, but they’ve actually been doing the exact opposite. So, here’s why companies blowing their cash
reserves and where all this money is going instead. THE DANGERS OF HOARDING:
Starting off with the most obvious reason, we have high inflation. During times of high inflation, idling cash
is rapidly losing it’s value, so it makes sense to decrease your cash reserves, but
it’s not actually that simple. If you look closer at these companies balance
sheets, you’ll see that many of them were starting to slash their cash reserves well
before inflation got out of hand. Inflation didn’t even cross 3% until the
2nd quarter of 2021. But, by this point, Apple had already decreased
their cash reserves from $107 billion down to $61 billion. This trend is even more evident at Microsoft
who has refused to increase their cash reserves since 2016 at this point. During this same time period, their net income
has rocketed from $25 billion per year to $70 billion per year. So, the choice to cap off their cash reserves
is very much an active one, but why? Well, a lot of it can be explained by Dr.
Michael Jensen’s research paper that was published way back in 1986. While nearly 40 years old at this point, this
research paper has become a bible for business leaders. The paper basically argues that holding cash
is a terrible sin for corporations and Jensen supports this idea with 5 reasons. We’ll take a look at the 3 most notable
reasons. The 1st reason is that there is an inverse
correlation between cash reserves and organizational efficiency. This makes sense and you can probably relate
to this yourself. When times are good, you’re more likely
to eat out more often, buy a phone you don’t need, or keep subscriptions that you don’t
even use. The same idea applies to companies. The more cash they have, the more likely it
is that they overhire employees, fund low ROI projects, and pay bloated salaries. Wait a minute, isn’t that the Metaver…anyway,
Jensen actually takes this idea to the next level. He not only argues that higher cash reserves
lead to lower efficiency but that higher debt levels increase efficiency. In other words, modest cash reserves and debt
are optimal for maintaining corporate efficiency. Moving onto reason #2, this is more of a observation
than an argument. Jensen observed that leverage increasing transactions
correlate with significant positive increases in stock prices while leverage decreasing
transactions correlate with significant decreases in stock price. The obvious reasoning for this would be that
companies taking on debt are likely funding some sort of expansionary effort while companies
that are reducing debt are likely taking risk off the table. Moving onto #3, this is likely Jensen’s
most contentious argument. He basically argues that larger cash reserves
lead to more diversification which is apparently bad. The idea is that companies are far more likely
to succeed when they invest in areas that they’re already dominant in as opposed to
a new area. As cash reserves grow, however, the temptation
to diversify into new businesses becomes larger which often leads to more losses than profits. These conjectures have simply been strengthened
over the years with newer research. One study for example analyzed corporate earnings
growth between 1871 and 2001. The study found that earnings grew the fastest
when corporate dividend payout ratios were the highest. In other words, when companies were paying
out most of their profits. Conversely, stock performance was poor when
companies hoarded cash. None of this is to say that cash reserves
themselves are leading to poor performance, but rather that bloated cash reserves are
generally a sign of a fundamental shift at the company, a shift that’s usually not
for the best. STRATEGIC STORAGE:
Alright so you don’t want to be holding onto too much cash as a corporation, but then
where do you put all this money? It’s hard enough to safely invest a few
hundred thousand dollars, so how in the world do you invest a few hundred billion dollars? Well, the answer usually breaks down into
3 main categories starting with short term securities. This primarily consists of government bills
that mature within the next 12 months. 1 year government bills are currently yielding
4.7%, so it’s a pretty solid bet for corporations. Not only are bills producing great returns
but they’re also considered risk free as they’re backed by the US government. In fact, they’re so safe that bills are
generally just counted as cash. Remember how we talked about Apple having
$50 billion in cash reserves. Well, only $20 billion of that is actually
cash cash, the other $30 billion is marketable securities or government bills. If we look even closer, we’ll see that even
the cash cash portion is not fully cash. The official title for the entry is cash and
cash equivalents. This basically means super short term government
bills that are maturing within the next month and/or money market funds. So, that’s where companies store the money
that they need within the next 12 months or so. As for longer term reserves, companies primarily
turn to government bonds once again, but this time the maturity is far longer, something
like 10 or 15 years. 10 year government bonds or technically notes
are currently yielding 3.3% which is much less than 1 year bills. But, the benefit is obviously that you get
to lock in this rate for a full 10 years. This is usually where companies store a bulk
of their cash. Apple currently has a whopping $114 billion
in long term marketable securities. So, basically all the cash goes to government
bonds of varying durations, but what if a company still has too much money left? Well, that’s where the infamous stock buybacks
come into play. Buying back stock allows for companies to
artificially inflate the value of their stock due to simple supply and demand. By purchasing stock, Apple is able to reduce
the amount of Apple stock that’s available on the market. At the same time, they’re also increasing
the demand for Apple stock because well, they’re buying hundreds of billions worth. In fact, over the past decade, Apple has bought
back wait for it $573 billion worth of stock. For perspective, that’s enough money to
buyout the 9th largest company in the world cash. Apple is not alone in trend either. Google has spent $150 billion within the past
5 years, Facebook has spent $100 billion within the past 5 years, Microsoft has spent $170
billion within the past 10 years, and corporations as a whole have spent $5.3 trillion on stock
buybacks within the past 10 years. So, investing cash into government securities
and stock buybacks has very much been the go to strategy for corporations historically. But, this has started to change in recent
times. THE NEW CURRENCY:
As you can see, large cash reserves are usually a dark sign for corporations, so they try
to make sure that cash reserves don’t get too out of hand by investing in government
securities and stock buybacks, but that’s the old school method. The new school method is to trade cash for
something much more valuable. The reality is that the value of cash is declining
and I don’t mean because of inflation. I mean that the fundamental value of cash
as currency itself is declining. This isn’t a new trend by any means. Cash has been a sub optimal currency for over
a hundred years at this point basically since the Federal Reserve was created back in 1913. It’s been engrained in our minds that currencies
lose value over time because that’s all we’ve ever seen with cash, but this is not
true. Good currencies increase in value and for
a very long time, cash was actually a great currency. In fact, between 1800 and 1900, the value
of cash actually increased. $1 in 1800 was only worth 67 cents in 1900. Think about that, money in 1900 was worth
more than it was in 1800. Of course, this changed with the fed but that’s
not to say that all currencies became inflationary. The new currency to hold was gold, atleast
until FDR banned gold in 1933. Following the ban, the new currency to hold
was oil. All of the richest people in the world between
the 1930s and 1970s were those who controlled oil. With the 1980s and reagonomics, however, the
optimal currency switched to being stock and that’s how it’s been since then. Billionaires like Jeff Bezos, Elon Musk, and
Bill Gates aren’t holding oil, gold, or cash, they’re holding stock, but this is
changing once again. The new currency is attention and the biggest
companies in the world know this more than anyone. This is why they’re more than happy to pay
ridiculous sums of cash to buy attention. Likely the best example of this is WhatsApp. When they were acquired, they were completely
worthless from a traditional business perspective. Despite having 450 million users, the app
was only bringing in $10.2 million in revenue and was losing $138 million. Another way to look at this is that each user
was bringing in a glorious 2.3 cents per year and losing the company 30 cents. Obviously a terrible situation from a financial
perspective. Facebook could easily go out and replicate
the app for no more than $10 million and even that’s being generous. But, what Facebook couldn’t replicate was
the interest that WhatsApp had, and that’s why they paid a ludicrous $19 billion for
the company or $42 per user. This is the same reason that Microsoft bought
Skype for $8.5 billion, why Apple bought Beats for $3 billion, why Microsoft bought GitHub
for $7.5 billion, why Microsoft bought LinkedIn for $26 billion, why Salesforce bought Slack
for $27 billion, and why Elon bought Twitter for $44 billion. None of these companies created something
truly revolutionary. More times than not, their products can be
replicated for a few hundred thousand or a few million max, but what’s nearly impossible
to replicate is their user base. And that’s why tech giants are blowing all
their cash acquiring these startups. Essentially, they’re trading their cash
and/or stock for attention as that’s the far more valuable currency. THE FUTURE OF BALANCE SHEETS:
For most people, being financially rich is defined by having a bunch of cash, but for
most companies, this is a nightmare. Growing cash reserves indicate that you’re
running out of places to invest and grow the company which is a big no no for investors. Traditionally, companies would trade their
cash for bonds and stock as those were the superior currencies, and these are still very
popular options today. But, more and more, we’re starting to see
companies trade cash for attention. They’re not looking for cash flow or solid
business fundamentals or a unique business or any of that. What they’re looking for is how to maximize
the attention that they can get for their cash as that is the real currency of the 1st
century. Currently, there’s still a bunch of companies
in the Fortune 500 that aren’t doing this, but give it 20, 30, 40 years, and the only
way to be in the Fortune 500 will be to control attention and that’s why the smartest companies
are blowing their cash reserves in return for attention. Did you realize how much money these companies
were spending on stock buybacks? Comment that down below. Also, drop a like if you’d like to see more
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