Corporate investments are the cornerstone of future growth. Yet shareholders are often seduced by buybacks and dividends. Equity investors should always make sure companies strike the right balance between deploying cash flows for short-term shareholder rewards and strategic reinvestment.

Running a company can be a messy business. CEOs of large, publicly listed firms often must choose between achieving near-term financial commitments and delivering long-term value creation. In our view, to create strong long-term return potential, companies must actively invest in new ideas designed to build a better business or generate long-term growth.

The Corporate Dilemma: Returns for Shareholders vs. Returns to Shareholders

US companies don’t look constrained by funding limitations. Our research shows that the top 25 US nonfinancial large-cap companies deployed more cash toward share buybacks and dividend payouts combined than on capital expenditures in 2017 (Display).

If funding is available, what keeps companies from spending more? Many companies don’t have enough good ideas to fund, while others lack vision. Bureaucratic governance structures may also hinder timely investment. Of course, tax reform could spur companies to launch new investment initiatives. However, many companies strive to grow earnings annually, which can also influence how they prioritize capital allocation and detract from their ability to sustain future profitability. In our view, many companies might be choosing not to fund good ideas because it’s simply easier to buy back stock, which flatters short-term EPS growth rates.

What’s wrong with that? The challenge is that maintaining high profitability often requires an intelligent trade-off between managing expenses while funding business model improvements and future growth opportunities.

Sustained investment is always vital to future shareholder value creation—especially in a world that’s rife with technological disruption. That’s why we believe investors should scrutinize companies for signs of underinvesting. Companies that underinvest might look healthy today, but their high margins may mask an underlying weakness: a lack of readiness for looming threats to a business model.