An Executive’s #1 Job: Capital Management

Written by the William Allan team · Published 2019-02-15T12:00:00.000Z

In February 2019, Senators Chuck Schumer and Bernie Sanders proposed restrictions on corporate stock buybacks tied to worker pay and benefits. Their published proposal raised a broader question: who should decide how a company uses its capital?

In my view, allocating capital is a central responsibility of management and the board. Those decisions matter to employees, creditors, and shareholders, and they deserve more than a blanket judgment that buybacks are always good or always bad.

For those unfamiliar with the term, a buyback is a company’s purchase of its own shares. Those shares may be retired or held as treasury stock. A reduction in outstanding shares increases the ownership percentage represented by each remaining share, but new issuance can offset repurchases. The net change in outstanding shares matters. A buyback also uses company resources, so its price and effect on the balance sheet need to be evaluated.

Needless to say, shareholders want management to do what’s in their best interests. And at the top of the list (maybe the only thing on the list) is do what’s best with the cash (i.e., capital) that the company creates. What’s “best” for the company and subsequently the shareholders, changes based on the current state of the enterprise, economic forecast, etc. This is where management earns its “keep”… by properly disbursing their capital.

A company’s capital needs can change as it develops. A growing business may reinvest heavily and seek outside debt or equity financing. A more mature business may generate cash beyond its immediate reinvestment needs. These are possible patterns, not stages every company follows. Management must weigh reinvestment, reserves, debt reduction, and distributions against the opportunities and obligations of the particular business.

Capital allocation is one factor investors may evaluate, but no management policy makes a company a successful investment regardless of its growth prospects or purchase price. Buybacks and dividends can return capital to shareholders, while poorly timed repurchases, excessive distributions, leverage, and underinvestment can destroy value. Future cash flows and shareholder returns remain uncertain.

As a shareholder, you are interested in the return on your investment. How management uses the company’s capital is one part of assessing that prospect, alongside the business outlook, risks, and purchase price.

Companies and securities mentioned are examples for discussion only, are not recommendations to buy or sell, and may or may not be held in client accounts. Any investment decision depends on the investor's objectives, risk tolerance, time horizon, tax situation, and other circumstances.

This commentary is for informational purposes only and is not investment, tax, or legal advice. All investing involves risk, including the possible loss of principal, and past performance does not guarantee future results.