Corporate Insights Capital allocation: paths to value
(2nd Quarter 2021)
- When markets are more benign or on the upswing, one of the biggest puzzles companies face is figuring what to do with excess cash
- In fact, our work shows that roughly two thirds of most companies' market valuations depend upon the market's view of how that money is spent … so understanding the value presented by these options is important
- For most companies, these options revolve around either investing in growth (capex or M&A) or returning cash to stakeholders (through buybacks or dividends) … or perhaps saving the cash for a rainy day.
- Smart capital allocation decision-making allows corporate managers to turn dollars of operating cash flow into outcomes that are worth more than those original dollars deployed
- Our latest paper – Capital Allocation: Paths to Value – looks at all of these options in detail … providing a useful tool to help our clients navigate their way to maximizing their market value by quantifying the actual returns that these capital allocation choices produce.
It isn't a trick question. But it is a question that corporate managers must answer to try to generate the most shareholder value through the deployment of excess capital. Great capital allocators generate excess returns for their investors because they can identify opportunities to deploy cash from their existing businesses into investments and strategies that are ultimately worth more than the cash used.
They understand that the market environment demands flexible and opportunistic approaches to investment opportunities. They have the discipline to retain or return excess capital when the market requires prudence, and they avoid expenditures on unproductive or risky projects that may destroy value. In essence, they can evaluate the value of a dollar spent on a variety of capital allocation alternatives.