Update on Uses of Cash & Subsequent Returns on Share Prices June 6, 2012

DeMarche

Update on Uses of Cash &Subsequent Returns on Share Prices

June 6, 2012W. Mark Meierhoffer

Practice Leader and Senior Consultant

Windy City Summit

DeMarche

Takeaway• Provide an Understanding of the

Alternatives Companies Use to Deploy Their Cash and Borrowing Capacity – What Have Been the Total Returns for Each Strategy?

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Topics Covered• Overview of DeMarche Associates• Update on General Stock Market

Environment• Study Background and Definitions• Study Results• General Conclusions

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DeMarche Associates

Defined Benefit Plan/Endowment/Foundation Consulting• Tactical Asset Allocation Policy• Investment Policy Development• Investment Manager Selection• Performance Measurement

Investment Management• Global Tactical Asset Allocation Fund• Specialty Index Funds

Corporate Finance/Investor Relations• P/E Valuation and Analysis• Dividend Policy Review• Treasury Buyback Analysis

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Products and Services

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Update on General Market Environment

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Data as of 3/31/12

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Source: (Top) Standard & Poor’s, FactSet, J.P. Morgan Asset Management.Price to Earnings is price divided by consensus analyst estimates of earnings per share for the next twelve months. Price to Book is price divided by book value per share. Datapost-1992 include intangibles and are provided by Standard & Poor’s. Price to Cash Flow is price divided by consensus analyst estimates of cash flow per share for the nexttwelve months. Price to Sales is calculated as price divided by consensus analyst estimates of sales per share for the next twelve months. PEG Ratio is calculated as NTM P/Edivided by NTM earnings growth. Dividend Yield is calculated as consensus analyst estimates of dividends for the next twelve months divided by price. All consensus analystestimates are provided by FactSet. (Bottom left) Q-Ratio based on data from the Federal Reserve, table B.102. *1Q12 is an estimate provided byJ.P. Morgan Asset Management as of 3/31/12. (Bottom right) Standard & Poor’s, Moody’s, FactSet, J.P. Morgan Asset Management.Data are as of 3/31/12.

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Source: (Top left) Standard & Poor’s, Compustat, FactSet, J.P. Morgan Asset Management. (Top right) Standard & Poor’s, Compustat, FactSet, J.P.Morgan Asset Management. Earnings estimates are for calendar years and taken at quarter end dates throughout the year. (Bottom) Standard &Poor’s, FactSet, J.P. Morgan Asset Management. Forward Price to Earnings is price divided by consensus analyst estimates of earnings per share forthe next twelve months.Data are as of 3/31/12.

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The Genesis ofDeMarche Research

• Absence of Academic or Practitioner Studies

– Long-term Time Frame

– Multi-Cap & Style Differentiated

– Multiple Use of Cash Strategies

– Segregated by Economic Sector & Industry

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Uses of Cash StudyDefinitions and Background

• Date of Study: 1990 – 2011 (22 years)

• 4,000+ Stocks

• Subsequent Annualized Returns Analyzed (For 1, 3, and 5 Years)

• Minimum Liquidity Requirement

DeMarche

Uses of Cash Study

METRICS: Distributing to Shareholders

1. Dividend Policy(Primarily Increases)

2. Stock Buybacks(Average Annual Repurchases Over Past 5 Years)

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METRICS: Reinvesting in the Business3. Mergers and Acquisitions (M&A)

(Cash M&A / Assets Over Past 5 Years)

4. Research and Development (R&D)(Total 5-Year R&D / Total Sales)

5. Capital Expenditures (CapEx)(Total 5-Year CapEx / Assets)

Uses of Cash Study

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Uses of Cash Study

Other Metrics Included

• Does Leverage Deter Returns?

• What about P/E?

• Does Free Cash Flow Matter?

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Uses of Cash StudyCap Size Ranges

• Large Cap: ≥ $20 Billion

• $2 Billion ≤ Mid Cap < $20 Billion

• $600 Million ≤ Small < $2 Billion

• Micro: < $600 Million

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Uses of Cash Study

Number of Observations by Cap Size

Large-Cap 3,400Mid-Cap 15,500Small-Cap 16,500Micro-Cap 36,200TOTAL 71,600

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HighRelative Price StrengthLow

HighEarnings GrowthLow

HighAsset GrowthLow

HighDividend GrowthLow

LowCash Flow YieldHigh

LowDividend YieldHigh

LowSales-to-PriceHigh

LowBook-to-PriceHigh

Growth StocksFactorValue Stocks

HighRelative Price StrengthLow

HighEarnings GrowthLow

HighAsset GrowthLow

HighDividend GrowthLow

LowCash Flow YieldHigh

LowDividend YieldHigh

LowSales-to-PriceHigh

LowBook-to-PriceHigh

Growth StocksFactorValue Stocks

VALUE TO GROWTH SPECTRUM

DeMarche Style Factors

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2011 Study Findings

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Total Universe of Stocks 6.68%Large Cap Stocks 7.61%Mid Cap Stocks 8.15%Small Cap Stocks 7.68%Micro Cap Stocks 5.16%

Value Stocks 7.50%Growth Stocks 5.80%

Review of Total Returns by Cap Size & Style

Three-Year Annualized Returns (1990-2011)

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All StocksUses of Cash Return Rankings

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USES OF CASH RETURN RANKS1-Year 3-Year 5-Year

Dividend Increases 1 1 1

Buybacks 2 2 2

M&A 3 3 3

CAPEX 4 5 5

R&D 5 4 4

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12%

10%

8%

6%

4%

2%

0%Cap Ex R & DDividend

IncreasesBuybacks M & A

8.30

* Median 3-Year Return For All Stocks: 6.68%

6.73 6.17 5.81 4.82

All StocksThree-Year Annualized Return Spreads (1990 – 2011)

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“Drill-Down” on Buybacks• By Cap Size & Style

• By Sector

• Effect of Leverage on Buyback Programs

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2011 (est) $437 bb2010 $299 bb 2009

$260 bb

Source: Standard and Poor's

Share Buyback Background

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Treasury Stock Buybacks by Cap Size and StyleThree-Year Annualized Returns

(1990-2011)

Companies Premium (Discount)By Size with Buybacks All Stocks to Index Returns

All Stocks 6.73 % 6.68 % 0.05 %

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(1990-2011)

Companies Cap Size Premium (Discount)By Size with Buybacks Index to Index Returns

Large CAP 7.98 7.61 0.37

Mid CAP 7.92 8.15 < 0.23 >

Small CAP 7.96 7.68 0.28

Micro CAP 4.88 5.16 < 0.28 >

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(1990-2011)

Companies Premium (Discount)By Size with Buybacks Style Index to Index Returns

Growth 5.96 % 5.80 % 0.16 %

Value 7.56 7.50 0.06

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Stock Buybacks 1990-2011Three-Year Annualized Return (10 Economic Sectors)

Information Technology

Consumer Discretionary

Materials

Health Care

Industrials

Consumer Staples

Telecommunication Services

Energy

Utilities

Financials 10.08% 10.25%

9.90% 10.12%

8.90% 9.94%

8.11% 7.11%

8.04% 7.88%

7.59% 7.25%

6.90% 4.72%

6.41% 5.91%

4.53% 4.20%

3.12% 2.23%

6.73% - 3 Year ReturnsAll Stocks with Repurchases


Premium DiscountWith to

Buybacks Sector Sector Returns

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0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

6.1%

5.3%

3.7%

5.7%

5.0%

4.4%

5.3%

4.2% 4.3%

Effects of Leverage on BuybacksAnnualized Three-Year Returns (1990-2011)

Highest Middle

Lowest

Retu

rns

Average Buybacks Smallest Buybacks

Leverage


Largest Buybacks

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“Drill-Down” on Dividends• By Cap Size & Investment Style• By Sector • Stratify by P/E• Summary of Various Dividend Strategies

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2011 1,953 101

2010 1,729 145

2009 1,191 804

Dividend Background

Source: Standard and Poor's

Initiations Terminations& Increases & Decreases

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Dividend Increases by Cap Size and StyleThree-Year Annualized Returns

(1990-2011)

Increasing Stable DecreasingDividends Dividends Dividends

Median 8.30% 6.89% 7.64%Returns

Median 3-Year Return for All Stocks – 6.68%

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(1990-2011)

Companies with Premium (Discount)By Size Dividend Increases All Stocks to Index Returns

All Stocks 8.30 % 6.68 % 1.62 %

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(1990-2011)Companies with Cap Size Premium (Discount)

By Size Dividend Increases Index to Index Returns

Large CAP 8.38 % 7.61 % 1.24 %

Mid CAP 8.85 8.15 0.70

Small CAP 9.12 7.68 1.79

Micro CAP 7.15 5.16 1.99

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(1990-2011)

Companies with Cap Size Premium (Discount)By Size Dividend Increases Index to Index Returns

Growth 8.55 % 5.80 % 2.75 %

Value 9.03 7.50 1.53

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12%

10%

8%

6%

4%

2%

0%0 – 10% 11 – 25% > 25%


Level of Dividend IncreasesThree-Year Annualized Returns (1990 – 2011)

8.25% 8.47% 8.31%

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Dividend Increases (By Economic Sector) 1990-2011Three-Year Annualized Return (10 Sectors)

Consumer Discretionary

Information Technology

Materials

All Stocks (w/Dividend Increases)

Consumer Staples

Industrials

Telecommunication Services

Health Care

Utilities

Financials

Energy 12.07% 9.94%

10.74% 10.25%

10.22% 10.12%

9.67% 4.72%

8.82% 7.11%

8.62% 7.25%

8.20% 7.88%

7.30% 5.91%

5.71% 2.23%

5.55% 4.20%

8.30%

With Premium (Discount)Dividend toIncreases Sector Sector Returns


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Does Free Cash FlowMake a Difference?

Free Cash Flow

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-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

9.33%

7.92% 7.91%7.33%

6.84%

8.32%

7.52%7.14% 7.02%

6.63%6.43%

3.52%

2.23% 2.36%

-0.59%

Free Cash Flow / Assets (Results for All Stocks)Returns by Use of Cash Category

Annualized Three-Year Returns (1990-2011)

Top Tertile

Middle Tertile

Bottom Tertile

Retu

rns

Dividends Buybacks M & A Cap Ex R & D


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Does Debt Matter?

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Dividends Buybacks M & A Cap Ex R & D0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

10.00%

7.62% 7.58%

6.69%6.93% 6.92%

9.39%

7.58% 7.42%6.92%

7.28%

7.87%

4.74%4.16%

3.15% 2.94%

Debt to Total Cap (Results for All Stocks)Returns by Use of Cash Category

Annualized Three-Year Returns (1990-2011)

Highest Debt / CAP

Middle Debt / CAP

Lowest Debt / CAP

Retu

rns


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ConclusionsIn General (When Ranking 4,000+ Stocks)

• Increasing dividends is the best use of cash

• Maintaining dividends is the second best use of cash

• Buybacks are the third best use of cash

• M&A in number four spot

• CapEx and R/D rank in the bottom

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Conclusions• Returns depend upon Company’s “DNA”

– Mid-Cap: Best Performer by size

– Value: Best Performer by style

– Dividend increases had largest positive effect on Growth Stocks and Micro-Cap Stocks

– Buybacks had largest positive effect on Growth Stocks and Large-Cap Stocks

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Conclusions• Higher Free Cash Flow equates to better total

returns

• Higher Leverage does not appear to negatively impact returns

• We are not advocating one use of cash strategy over any other - Need to balance between reinvesting in the business and rewarding shareholders

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DeMarche Associates913-384-4994

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Update on Uses of Cash & Subsequent Returns on Share Prices June 6, 2012