In the collective coffers of public American companies, you'll find roughly a trillion dollars in cash and cash equivalents. According to Thomson Reuters data, that number tops $4 trillion globally. With all that money just lying around doing nothing, many investors and pundits alike are clamoring for more dividend payments. Dividends are truly wonderful, and hefty dividend payers fully deserve a berth in your portfolio. But that doesn't mean that direct payments to shareholders are always the best way a company can use its stockpile of cash.
Aside from paying dividends, a company can use its money to pay down debt, buy back shares, build its business, acquire other companies, and more. We shareholders want as much bang for our buck as possible from our companies. A dividend payout is nice, but it doesn't increase the value of the company the way a smart acquisition or further research and development might.
Dividend-beating spending
True, such spending doesn't always work out well. Poor results forced Pfizer to halt trials of its cholesterol drug torcetrapib in 2006, after investing $800 million on its development. But for all the expensive projects that fizzle out, plenty of others can prove well worth their cost. Even with the end of its patent protection looming, Pfizer's chief cholesterol-fighter, Lipitor, still generates almost $12 billion annually!
A smart acquisition can also be a very effective value-builder for a company. Disney (NYSE: DIS) bought Pixar for more than $7 billion in 2006, enabling Pixar to produce more films that it probably could have on its own. Toy Story 3 alone grossed more than $1 billion worldwide, and others such as Finding Nemo, WALL-E, Monsters, Inc., Up, and Ratatouille have each grossed more than $500 million. And those figures don't even count the cash Disney rakes in from merchandise based on those films and their characters, or home video sales. In the long term, buying Pixar has benefitted Disney and its shareholders far more than any additional dividend payments.
The merger of two satellite radio operators that resulted in Sirius XM Radio was another seemingly smart move -- at least for the companies, since it helped them eliminate redundancies and cut costs. Whether the services' reduced competition ultimately benefits consumers remains to be seen.
Choices to make
Many companies now sitting on a lot of cash have critical allocation decisions to make. Look at Visa (NYSE: V) and GPS specialist Garmin (Nasdaq: GRMN). Visa holds $4 billion in cash and equivalents, which it could use to boost its relatively puny dividend. But as smartphones now threaten to become widespread payment tools, Visa might do better to spend a considerable sum developing or buying technology that will help it participate in this new trend, rather than getting sunk by it.
Similarly, Garmin has around $1.2 billion, but it can't afford to become complacent and give that cash to shareholders. GPS devices are becoming commodities, increasingly found in smartphones and cars, and the company needs to find ways to maintain and grow its revenue. Its attempt to compete with companies such as Research In Motion and Motorola with its Nuvifone didn't pan out, but it can still profit from smartphones by licensing its technology, if not by developing a new offering that consumers embrace.
Listen to Warren
For proof that a company can reward shareholders even without dividends, look no further than Warren Buffett's Berkshire Hathaway. It's sitting on more than $34 billion in cash as of Sept. 30, and adding billions annually. Buffett has explained that as long as he can find effective investments for his cash, he won't be paying a dividend. In 2009, he spent some $44 billion on the Burlington Northern railroad, and it's estimated that he may have added more than $10 billion in value via that investment already.
The most amazing stock performers do often pay dividends, but they're no less wise to hang on to a fat chunk of cash. A well-stocked piggy bank can give them even more options for building value.
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