3 Implications of Companies Hoarding Cash

"Save for a rainy day." How many times have you heard that phrase? For many of us, it's good advice. It's scary to scramble to find cash when an emergency occurs. But for companies, it's not so straightforward. Saving for a rainy day is not the best use of investor money and causes companies to hoard cash. This article is about 3 implications of companies hoarding cash.

Implication #1 - Missed opportunities

Companies have the power to create wealth. They do this through innovative use of assets. They obtain the assets and transform them into products or services that can improve our lives, or at the very least, sustain them.

Related: The Impace of Opportunity Cost

Conversely, a bank account doesn't do much to increase wealth of anyone but the bankers themselves. Have you taken a look at interest rates on savings? Even in this high inflationary environment, banks are quite slow to increase the rates they'll pay out. 

If companies hoard their money, they are likely keeping it in some kind of bank account, usually a money market account. How can they be putting that money to good use when it is sitting in a low-paying interest-bearing account?

Implication #2 - Investors can put money in a savings account

Why would investors take the risk of investing in a company just to have the company place earnings in a low-paying interest-bearing account? Investors are certainly capable of putting money in a savings account themselves. Essentially, investors are taking on risks with little reward.

Implication #3 - Management doesn't know what it's doing

Managers should have a vision on how to grow the business. Putting earnings into savings is not indicative of a management team that is competant. Certainly, there are instances where building up cash is warranted (in the short term). Expanding the business is a good example of this.

But companies that habitually save lots of cash will not likely stay competitive because they don't have a vision of how to grow the business.

Unofficial 4th Implication

This is similar to poor management but think about the message hoarding cash send to the investment community. Solid companies don't have to worry too much about cash flow because they will produce new profits each month for the foreseeable future. They are confident in their abilities to do so. 

When a company starts hoarding cash though, is it because their economic engine has run out of steam? Why should you take on the brunt of this mismanagement? 

Maybe the company will bounce back. But then again, this should be a serious warning that the economics of the business have changed.

Are there exceptions?

There can be legitimate reasons for companies to hoard cash temporarily. But they should make you feel uncomfortable when companies do it. It should raise your suspiciousness about the company and if it doesn't get resolved soon or without a reasonable explanation for why it's happening, it may be time to sell and move on. Remember, you can put the money in a bank account, which is much safer then keeping it in a company that isn't putting the money to good use.

The main exception would be expansion, but don't let managment use that as a buzzword. Insist on finding companies and management teams that explain in detail what their plans are for the cash in the future and for how long they need to hoard it. If you don't get an explanation you feel is reasonable, it may be time to throw in the towel. 

Having said this, give the company a chance if they do provide a decent explanation. But you should monitor the situation closely and if time passes and nothing changes, that not a good sign.

Be Critical and Selective

Assuming from the last section that you did give the company the benefit of the doubt,  but it didn't follow through, don't hang onto the hope that something will change. It's okay to be critical and selective. After all, it's your money and you want to maximize your gains.

The company probably sold you on maximizing its gains which is likely why you bought the stock in the first place. Since the company failed to produce, you owe them nothing and are not required to stay with them.

Bottom Line

If companies are not clear on what to do with excess cash, they have an obligation to pay it back to investors in the form of a dividend. View hoarding cash as a red flag. It warrants further investigation before placing your hard-earned cash into companies that hoard. 

You want companies to take calculated risks. That's what allows the create returns on investment that exceed savings accounts or even bonds.

Companies that are habitual hoarders of cash will always find themselves playing catch-up when competitors have been reinvesting wisely.