What Corporate Cash Use Helps Stocks Most in the Pandemic?

What’s the best use of corporate cash to generate stock appreciation? Share buybacks? Research and development (R&D)? Dividends?

Betcha guessed buybacks. Sorry. It’s how much a company uses its cash in mergers and acquisitions (M&As), at least in recent pandemic times. That’s according to a study from Goldman Sachs. “M&A represents a flexible way to deploy cash on a shorter time frame,” wrote David Kostin, the firm’s chief US equity strategist, in the research note.

Indeed, companies that use most of their cash for M&As have a record as being the best-performing group. During 11 of the past 19 quarters, they have outpaced companies prioritizing other uses, such as dividends, R&D, or buybacks. That means the trend goes back through 2017. In fact, the M&A-centric cash disbursers have outperformed the S&P 500 by nearly 4 percentage points annually during that period.

Narrowing the focus to the pandemic, Goldman screened S&P 500 names from each sector with the highest cash M&As as a share of market cap over the last completely reported four quarters—meaning starting in 2020’s third period, right after last year’s disastrous second quarter.

Among the top M&A-tilted cash spenders are casino operator Caesars Entertainment, biotech outfit Gilead Sciences, bank holding company PNC Financial, and telecom giant AT&T.

Just how these acquirers will fare going forward remains to be seen, frankly. Caesars spent $8.4 billion on buyouts during the past four quarters. A lot has to do with the recovery of casinos, which have regained some popularity but still are below their pre-pandemic attendance. The company remains in the red for the year, although it eked out a small profit in the second quarter and is expected to do the same for the third, when it reports after the markets close Tuesday.

Caesars has a long history of M&A activity, which has made it the largest US casino corporation. In April, Caesars bought online betting operator William Hill for just over $4 billion. Of course, these additions weren’t solely from cash; a lot of leverage was involved, too. With a large debt load, Caesars had better bet that casinos come back really strong. Investors are wagering that it will: The stock is up 51% this year.

Gilead laid out $23 billion on M&A during the four quarters, or 27%. Deals included Forty Seven for $4.9 billion (specialty: seeking to use the immune system to fight cancer), Immunomedics for $21 billion (same area), and MYR GmbH for $1.5 billion (hepatitis treatments). Gilead is solidly profitable, and just beat analysts’ projections for its most recent quarter. The stock is up 16.3% year to date, and at a price/earnings (P/E) ratio of 11, remains quite affordable.

Goldman even believes that a proposed 1% surcharge on buybacks could aid M&As and wouldn’t harm the bull market. Reason: Even more cash would go into acquisitions. (A previous Democratic proposal to increase the corporate income tax from its current level of 21% would have shaved 5% from S&P 500 earnings, Goldman had estimated. That plan appears to be dead, though.)

“We expect a possible buyback tax would have a limited impact on the overall equity market, although on the margin it would represent a tailwind to other cash spending uses,” Kostin writes.