In his first-quarter letter to shareholders, top fund manager Bill Nygren of Oakmark says that he’s keying on companies that are putting their cash to work.
“Corporations today have unusually strong balance sheets and are generating much more cash than they can profitably reinvest in their own businesses,” Nygren writes. “Unless managements just let the piles of cash keep growing, which is clearly suboptimal, there are only three ways to deploy it: higher dividends, share repurchases and acquisitions. And companies are doing all three.”
Nygren says that most investors don’t focus on those uses of cash. “They assume that EPS growth and dividend growth will mimic organic net income growth and that, when they diverge, it is unsustainable,” he says. “We believe that historically low dividend payout ratios make it likely that dividend growth will exceed EPS growth for years to come.” Last year, he says, the S&P payout ratio was 30%; from the 1960s to the 1980s, it was 50%. “If earnings grow at 5% per year, and if by the end of the decade the payout ratio has returned to 50%, annual dividends will have grown at a double-digit rate, more than double the rate of earnings growth,” Nygren says. He adds that he thinks EPS growth will exceed organic net income growth. “Most of the share repurchases and acquisitions that our companies made last year were funded from cash generated in the normal course of operations, not from a one-time levering up of their balance sheets,” he says.