Corporate finance is not the stuff of kitchen-table conversations. The terminology surrounding it is a bit obscure. And a lot of the key data isn't officially tracked by the government or published in an easily accessible way.
But these four sentences by Lu Wang and Callie Bost at Bloomberg tell us an enormous amount about where the economy is today. They start with the observation that big companies are poised to spend about 95 percent of their profits this year on dividends and share buybacks. And there's a larger trend:
CEOs have increased the proportion of cash flow allocated to stock buybacks to more than 30 percent, almost double where it was in 2002, data from Barclays show. During the same period, the portion used for capital spending has fallen to about 40 percent from more than 50 percent. The reluctance to raise capital investment has left companies with the oldest plants and equipment in almost 60 years. The average age of fixed assets reached 22 years in 2013, the highest level since 1956, according to annual data compiled by the Commerce Department.
What does this mean? It means that the basic link between healthy corporate profits and a healthy middle class is broken.
The question here is what happens to the cash when a big company makes a profit? Initially, it just sits in the corporate equivalent of a bank account. But eventually you spend it on something. You could spend it on expanding your business — buying new equipment, leasing more office space, and hiring more workers to do it. Or you could give it to the people who own stock in your company. (Terms: A dividend is when you mail each shareholder a certain amount of money per share that he owns. A buyback is when you go on the open market and buy a bunch of shares of your company's own stock.) Either way, money heads out of the corporate treasury and into the pockets of shareholders.
Of late, more and more companies have been choosing to spend more and more of their profits on the people who own stock in their companies.
There's nothing wrong, per se, with dividends and buybacks. Just because a company is profitable doesn't mean it has amazing investment opportunities. Companies with below-average prospects should spend most of their profits on dividends and buybacks so that rich investors can plow that money into companies with better opportunities.
But if every business acts like a piggybank for rich shareholders rather than investing in the future you have a huge problem. For starters, the economy becomes less productive as equipment ages and goes obsolete. But more than that, without new investment there's sluggish job creation and scant opportunity for people to earn raises. And worst of all, when nobody's investing then nobody else wants to invest either. If the factory isn't expanding, then it's probably also a bad time to open up a new restaurant or for the local car dealership to add to its inventory.
The status quo is fine if you happen to already own a giant pile of stock. You'll keep getting paid out of high profit margins even if there isn't much growth. But for people who work for a living it's a terrible outcome.