Reinvesting in the business

If you own a home, you know that somewhere in the basement is a sensor that’s linked to your bank account. Too much cash on hand? There goes the furnace! Getting a bit ahead? Where did that leak in the ceiling come from? Just finishing the car payments? Look, we have bats in the attic!

Chaplin_-_Modern_TimesMany of these woes can be prevented, or at least postponed, by regular maintenance. While spending $5.000 on a new roof is probably the least exciting way to spend a five large, it’s way more fun than replacing your entire kitchen after a downpour, and cheaper, too. For many companies, capital expenditures are unexciting — but good for the firm and its profits in the long run. Unfortunately, it may take Wall Street a while to get used to the notion.

In recent years, companies have been delaying reinvesting in their people and equipment, while hoarding cash and buying back shares. But this, like putting off that new roof, has its drawbacks. If you don’t pay people well, they go away.  If you don’t modernize your equipment, your product quality falls behind.

Furthermore, while capital expenditures detract from a company’s earnings in the short term, they are a powerful driver of the economy. When you start buying new forklifts, computers or delivery trucks, other companies typically see their profits rise — and they start hiring as well. It’s a virtuous cycle.

Reinvesting in capital equipment is good for a company in the long run. Nasdaq has an admittedly obscure index called the Nasdaq US CapEx Achievers Index, which tracks companies that have increased capital expenditures for three consecutive years.

Through 2014, the CapEx Achievers index has gained an average 15.99%, according to Nasdaq, vs. 15.45% annually for the S&P 500. And for the past five years ended July, CapEx Achievers have gained 119.5% vs. 91.7% for Dividend Achievers — stocks that have raised their dividends each year for 10 years or more.

Big investments in business don’t usually please investors, who often have the attention span of a gna. For example, investors punished Walmart stock Tuesday in part because the company has been increasing its investment in its U.S. stores, and raising salaries, albeit reluctantly. (The rising dollar also hurt its returns from overseas). So far this year, several of the CapEx achievers have also been clobbered:

  • Chevron: -19.6%
  • Procter & Gamble: -13.6%
  • Oracle: -10.3%
  • 3M: -6.7%

Nevertheless, capital spending does seem to be coming back into vogue. If you take out energy spending, which is in clear contraction, capital expenditures for companies in the Standard and Poor’s 500 have risen 9.4% the past 12 months.. And, says S&P, strategies to woo shareholders — buybacks and dividend increases — are set to fall slightly in the second quarter both on a quarterly basis and last 12 months.

If, in fact, companies are starting to loosen their purse strings for a bit, that’s good news for the economy. But it may also foretell a slowdown in earnings — and stock prices — in the next few quarters. But that seems like a relatively small price to pay for much-needed improvements.

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