The Ugly Leadership Horsefly in the Record DJIA Economic Ointment
The Dow Jones Industrial Average (DJIA) jumped to record levels - over 15,000 - today after a favorable U.S. jobs report showed 165K new jobs and a drop in unemployment to 7.5%. Politicians, economists, business leaders and investors were buoyed by economic improvements and the hope for further growth. A higher stock market is considered a great ointment for what has hurt America the last several years.
But there's a big, ugly fly in this ointment. While the indices are rising, revenues at many very large, key component companies are actually declining. And possibly worse, the revenue growth rate for large companies has been declining for at least 3 years.
As the chart shows, Caterpillar has led the revenue decline, dropping a whopping 17.5% year-over-year. But noteworthy declines included JPMorganChase dropping 15.5%, Pfizer down 12.4% and Merck down 9%. It's hard to imagine a great long-term bull market when revenues are distinctly going in a bearish direction for several stalwart companies.
It is also important to note that the rate of DJIA growth has declined markedly. In 2011 first quarter growth was 11.4% over 2010. But 2012 was only 9.4% over 2011 and 2013 came in only a paltry 3.8% over 2012. Ouch! Clearly, jobs growth will not be sustained if these organizations cannot put more money on the top line.
So why aren't these companies growing?
For companies to grow they must invest in new products, new markets and the resources to sell and deliver these new products and new markets. And that creates jobs. Think about easy to identify revenue successes like Apple (iPads,) Samsung (smartphones,) Amazon.com, Netflix, Tesla, Facebook. Proper investment leads to revenue growth opportunities.
But, unfortunately, America's leaders have reduced their investment in growth projects the last 15 years. Instead, they've been giving more money to investors -- and increasingly dumping money into stock buybacks that manipulate price and help improve management bonuses!
Source: Business Insider 4/8/13; Sam Ro; Reproduced from Goldman Sachs Research
As the chart demonstrates, in 1998 42% of corporate cash was reinvested into the means of production - which creates growth. Today this has declined to only about 1/3 of available cash; a whopping 25% decline! Additionally, R&D investments which should lead to new products and higher sales, dropped from 16% of cash used a decade ago to a more meager 12%!
Where has the money gone? 13% of cash was going directly to investors, who could then invest in other companies with higher rate of return growth projects. That number has risen to 18%, which is inherently a good thing as we can hope a lot of that has been re-invested in other companies.
But 13-17% used to be spent on stock buybacks, which create no revenue or economic growth. All share buybacks do is exchange cash for shares, reducing the number of shares and changing metrics like earnings per share and thus the price/earnings (P/E) multiple. It does not create any new investment. That number has risen to a staggering 22-34% of revenues!
Net/net, in the not too distant past America's leaders were putting 70-74% of their cash to work by investing in growth projects. And 12% was going to investors for projects elsewhere. By in the mid-1990s this reinvestment rate declined to 52-55%, ushering in the Great Recession. After improving this rate has started declining again, and remains stuck no better than 60% of cash. Coupled with the 5% increase in cash being robbed from growth projects to buy back stock, the net reinvestment remains mired at 55%!
American's want jobs and a growing economy. As do people everywhere! We are excited when we see improvement. But today, the ugly horsefly in the ointment is the lack of revenue growth - and the lack of investment in growth projects. Until business leaders begin putting their corporate cash hoards into growth projects again the long-term outlook remains problematic, even if the market is hitting record DJIA highs.