I loved this Tweetstorm from The Secret CFO on capital allocation.

You should read it in full, but the key point for me is that if a company has capital to invest, the default position should always be to return it to shareholders via a stock buyback or a dividend.

There are three things a company can do with capital:

1/ strengthen their balance sheet (hold cash or pay down debt)
2/ invest in growth
3/ return capital to shareholders.

The default position should be #3.

There’s an old saying that “profitable companies have run out of ideas.” Meaning that if you make a profit it means you’re not investing in new products and services that will drive future growth. This is a fun saying, but it sort of implies there’s something wrong with being out of ideas or taking a profit. Of course, there’s nothing wrong with this. Companies are designed to create shareholder value. Generating profits and giving the cash back to investors so that they can go out and spend it or invest it as they please is the definition of creating shareholder value. Apple, the most profitable company in the country, had a net income of just under $100 billion last year and paid out a large part of it to shareholders in the form of dividends. They’ve created a high hurdle for new investments in growth. If they don’t expect a new initiative to create a huge amount of value, they default to returning that capital to shareholders.

Obviously, in the early stages of a company, the priority has to be building something such that generating profits is even possible. In these cases, all available capital goes towards growth. But later-stage companies that are generating a material amount of cash through their core business should default to giving capital back to shareholders. Using this as the default position creates a very healthy discipline, ensuring that new investments in growth are fully thought through and approved with the proper amount of analysis, rigor, and skepticism.