G193

Last year's financial depredations reduced the strategy for deploying corporate cash to one word: "don't." Companies reduced spending, cut payouts to shareholders and curbed deals to conserve cash.

Mostly, they did well. Compared with 2008, the median ratio of free cash flow, after capital expenditure and dividends, to debt for nonfinancial companies increased substantially at nearly all ratings levels by the third quarter of 2009, according to Moody's.

This was what investors wanted. But that is changing -- leaving treasurers in a quandary. Prodded by low interest rates, investors' taste for risk has revived. The Standard & Poor's 500-stock index's forward price/earnings multiple is 15.2 times, up from 11.5 times last April. Citigroup's Financial Strategy Group splits price/earnings multiples into a theoretical "base" component reflecting the cost of equity for existing profits and a "growth" element. This methodology suggests the growth element has risen from accounting for 8% of the global stocks' median price/earnings ratio in December 2008 to 45% now. Today, reckons Citi, large, nonfinancial companies hold an incremental $290 billion of cash above 2007 levels. More than half of that is in the hands of U.S. firms. Such hoarding is untenable, not least because hedge funds, private-equity firms and tax men are drawn to idle cash piles like bees to pollen.

Treasurers have three broad options. One is to increase capital expenditure. Economic-growth prospects, however, look sclerotic, and U.S. industrial-capacity utilization still languished at 71.3% in November, according to the Federal Reserve. Miners and oil producers, subject to the China effect, enjoy much higher utilization. But makers of machinery, computers, apparel, communications equipment and vehicles suffer rates well below 70%.

Companies can buy each other instead. Global M&A surged by 90% quarter on quarter to $626.8 billion in the last three months of 2009, according to Mergermarket. Although a return to the frenzied days of 2007 looks unrealistic, some revival of M&A looks certain, as firms seek to expand profits by combining operations and cutting costs rather than relying on sales growth. Market crises, by depressing valuations and shaking assets loose, offer the best pickings.

The real comeback this year, however, is likely to be in shareholder payouts. Given the uncertain economic backdrop, dividend increases could well be restrained, for fear of stoking expectations too high. Instead, watch for more stock buybacks. S&P 500 buybacks dropped from $597.8 billion in 2007 to just $89.7 billion last year, according to Birinyi Associates, a research firm. But authorizations for new buybacks jumped in the fourth quarter. Last week, retailer Target said it would resume a $10 billion program suspended in 2008. Target's shares rose on that news, although probably more because of the positive signal it imparted on recovering company cash flow.

Besides such symbolism, buybacks are tempting for management for another reason. Citi calculates the 100 largest U.S. firms by market capitalization relied on share buybacks for fully one-third of their growth in earnings per share from 2003 to 2008.

Be warned: Executives can make lousy buyers of their own companies' stock. A recent survey of 26 industrial companies by Morgan Stanley found more than half had made a zero or negative return on stock repurchases since 2000. But buybacks will be a preferred strategy for trying to square low growth and a cloudy outlook with the earnings expectations implied by high stock-price multiples.