Last summer Michael Mauboussin, managing director and head of Global Financial Strategies at Credit Suisse Group AG, gave investors a detailed explanation of the five principles he uses to evaluate capital allocation decisions: zero-based capital allocation, funding strategies instead of projects, avoiding capital rationing, zero tolerance for poor growth, and knowing the value of your assets. He used historical capital allocation trends in the US to highlight his points, but asset allocation can and should vary between economies.
Now Mauboussin has returned to the theme of global capital allocations to help investors understand why regional trends can be so different outside the US (n.b. all graphs refer to the top 1000 companies in the region excluding financial services and utilities).
“The patterns in the U.S. and Europe are similar, with relatively strong spending on R&D, solid capital expenditure levels, active M&A, and a relatively generous shareholder yield. The CFROI in the U.S. is substantially higher. Japan has a low CFROI and relatively modest growth. M&A is also muted, and shareholder yield is low—although there has been improvement in recent years. Developing markets spend an above-average amount on capital expenditures and working capital. But they have low shareholder yields and allocate little to R&D,” writes Mauboussin, giving an overview of the differences between regions.
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European v Japanese capital allocations
Broadly speaking, European capital allocation is similar to the US. European companies both spend less on mergers and acquisitions than US companies and are more willing to divest. European companies also favor dividends instead of buybacks (the opposite is true in the US), but the differences are really a matter of degree as you might expect.
Japan, despite being a developed economy like the US and Europe, has a dramatically different capital allocation history. Capex and research are the largest categories, as you might expect from a country known for its tech industry, while M&A activity is extremely low (with the occasional cyclical highs). Dividends and buybacks are also much lower, which is related to the fact that Japanese companies aren’t able to internally fund as much of their spending as their American and European counterparts.
Capital allocation in GEM and APEJ
Mauboussin presents data for global emerging markets (GEM) and Asian Pacific excluding Japan (APEJ) separately, even though there is a lot of overlap between the two groups (as he himself points out), so the similarities between them aren’t surprising. Buybacks are almost non-existent in both regions, though dividends are comparable to Europe. More striking is that R&D is clearly not a priority at all, as M&A plus capex takes up about 70% of allocations. Since energy, materials, and industrials make up a large proportion of the GEM and APEJ economies the heavy allocation to capex in particular makes sense.