All but the last option are acceptable uses. It is management’s responsibility to choose the option that is in the shareholders’ best interest.
In recent years, many companies have chosen to pay out profits in dividends or repurchase shares of their own stock. Both of these choices are good for shareholders.
Stock Value Increases
Paying out an increased dividend puts extra cash in stockholders’ hands and increases their total return on their investment in the stock.Repurchasing shares of stock benefits owners by reducing the number of outstanding shares, thus making the remaining shares still on the market more valuable.
However, the one option that fewer companies have chosen in recent years is reinvesting profits in expanding their business. A recent story in the Wall Street Journal notes that this lower than normal contribution to expanding businesses has resulted in a slower growing economy.
Stock Benefits
While investors my have enjoyed the benefits of dividends and stock buybacks, the downside has been an economy that is growing at an average rate of less than 2 percent over most of 2006-07.That slowing growth rate has not resulted in a lower inflation rate, which you would expect, the WSJ notes.
A slow growth rate for the economy does not portend well for future corporate profits. If inflation continues to remain stubbornly resistant to a stagnant economy, companies may not be able to look forward to lower interest rates in the future.
This sounds disturbingly like stagflation, that condition where the economy stalls, but inflation remains high. Stagflation is one of the most difficult economic conditions to break.
To break the hold of stagflation, we may have to decide that a small amount of inflation is price of moving the economy forward.
