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Investing? Rather not …

11 July 2019

 Salomons Judgement

Why don’t companies invest? Because they see no growth? Perhaps. Because the need is missing? That’s more likely. But also, because they’re not rewarded for it by investors.


Endurance athletes often enjoy listening to music. It helps them to get through the tough moments. The podcast is an alternative to music. Therefore, a tip: the podcast by Barry Ritholtz, Bloomberg columnist and founder of Ritholtz Wealth Management. One of his guests, Chris Brightman, recently made a brilliant link between the macroeconomy and finance based on my favourite Fama and French factors. Companies invest less because investors appreciate that more. 

In the early 1990s, Nobel Prize winner Eugene Fama and Kenneth French wrote a scientific article invalidating the notion that financial markets always work efficiently. They became known for their 3-factormodel which, in addition to the market factor, also gives room for the risk factors ‘value’ and ‘size’. Inexpensive shares (based on their book value) and shares of relatively small companies (based on their market capitalisation) perform better than might be assumed based on their market risk. At least in the long term. French reminded me of that important nuance himself. 

In 2014, Fama and French came up with a 5-factormodel, which also left room for ‘profitability’ (shares of profitable companies perform better) and ‘investment’ (shares of companies with a high asset growth have lower than average returns). The last factor is also the link with the macro economy. Investors seem to have no desire for companies that invest heavily. On the stock exchange, companies that invest conservatively do better than companies that invest aggressively. In 5-factor terminology, this is called the CMA factor (conservative minus aggressive).

The CMA factor can be explained well. With sufficient profitability you simply need less investment. This is standard corporate finance literature. Companies with high returns on capital can still realise the same cash flow. The right decision on a micro level; at the macro level, we complain about the lack of investments. That is not necessarily beneficial for the economy in the long term. We will have to learn to live with that. You cannot blame companies for investing less if profitability is high. The only solution is to stop complaining.

If the high returns on capital result from a lack of competition, however, that is a more serious problem. And there is some evidence pointing to way. Economist John Van Reenen of the MIT Department of Economics and Sloan Management School shows in a whitepaper that the concentration of companies has increased in every sector.

But you cannot blame companies for protecting their positions of power either. Anyone who wishes to complain about this can go to the polling booth. And then demand politicians to appoint a tough regulator. Governments cannot offer much counterbalance to power concentrations, apart from redesigning taxes and breaking up cartels.

The author

Roelof Salomons

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