Companies must talk more about the future
ONE way I like to think about the stock buyback debate is that it's a debate over who should get to allocate capital to projects. Some people think that if the manager of a company is skilled enough to make money for that company, she should get to hold onto it and invest it in new projects. After all, she has shown that she is able to make money. Other people think that she should give the money back to the shareholders, so they can invest it in new projects. After all, it is their money, and they have shown that they are able to invest it profitably. Neither of these views is unassailable, and for roughly the same reasons: Past success, in business and in investing, only weakly predicts future success. But there the money is, and someone has to decide what to do with it.
This debate is sometimes described as one about long-termism versus short-termism, with long-termism meaning that the managers get to keep the money for a long time and short-termism meaning that they don't. Larry Fink, the chief executive officer of BlackRock, is one of the best-known advocates of long-termism, and a member of thesecret club of investors that we talked about this morning, which meets to plot ways to make companies more longterm-oriented. Yesterday, Fink sent a letter to more than 500 companies saying that they should keep their money, but tell investors how they're going to spend it:
While we've heard strong support from corporate leaders for taking such a long-term view, many companies continue to engage in practices that may undermine their ability to invest for the future. Dividends paid out by S&P 500 companies in 2015 amounted to the highest proportion of their earnings since 2009. As of the end of the third quarter of 2015, buybacks were up 27% over 12 months. We certainly support returning excess cash to shareholders, but not at the expense of valuecreating investment. We continue to urge com- panies to adopt balanced capital plans, appropriate for their respective industries, that support strategies for long-term growth.
We also believe that companies have an obligation to be open and transparent about their growth plans so that shareholders can evaluate them and companies' progress in executing on those plans. Fink's letter has gotten a lot of attention for its call for companies to "move away from providing" quarterly earnings guidance: "Today's culture of quarterly earnings hysteria is totally contrary to the long-term approach we need." But its vision of how companies should be managed is also revealing.
Fink thinks that companies should be managed by their managers. This doesn't sound especially revolutionary, when you say it like that, but of course there is a competing view. Lots of investors think that they have some pretty good ideas for how companies should be managed -- buybacks are often involved -- and aren't shy about proposing them. Sometimes those proposals are appealing, even to long-termers, and BlackRock sometimes backs them. "Nevertheless," writes Fink, "we believe that companies are usually better served when ideas for value creation are part of an overall framework developed and driven by the company, rather than forced upon them in a proxy fight."
It's useful to keep the capital-allocationdebate model in mind as you read this letter. Fink's message to managers is that they, rather than activist investors, should take the lead in deciding what projects should get funded. But Fink is very different from the average activist investor. In particular, he doesn't have a concentrated portfolio of high-impact activist bets. He runs a company that is really good at index funds and exchange-traded funds. At least on the equities side, BlackRock's business model is about diversified ownership of many companies. And it doesn't have much of a choice: BlackRock manages $4.6 trillion, and the long-term investors' club combines for more than $12 trillion, which comes to more than two-thirds of the entire value of the Standard & Poor's 500 Index. BlackRock, and the long-term club generally, basically own the whole market, because they have to.
If you own the whole market, capital allocation isn't the source of joy and outperformance that it might be for Carl Icahn or Bill Ackman. If a company's management, in an exercise of discipline and self-negation, decides not to reinvest its profits but instead hand the money back to you, what can you do with it? You have already put your money everywhere; where else can you put it?
If you own the whole market, you are unlikely to get a lot of performance by choosing the best projects to invest in, or to develop any particular skill set in doing that. You're choosing all the companies, with all the projects. You're much more likely to get performance by letting the managers of all those companies discover new projects and allocate capital to them. If they give the capital back to you, you're just going to index it anyway. You're not going to make the wild bets on the future. You're relying on corporate managers to do that.