Strategy

How to Discuss Capital Allocation With Investors

CFOs should offer shareholders a broader discussion about capital spending and the rationale behind it.
Govind Gupta and Akhilesh KulkarniMay 31, 2022
How to Discuss Capital Allocation With Investors
Photo: Getty Images

Your company could have a highly successful capital allocation strategy, but, if you’re not sharing that story with investors, you’re missing an opportunity to add value and build trust. Recent EY research indicates most companies don’t communicate enough details with their shareholders about capital spending. This is happening even when companies have positive results and a compelling message.

  Govind Gupta

CFOs frequently ask for examples of companies that communicate their capital allocation strategy most effectively. To identify useful examples, EY teams examined analyst discussions and shareholder communications for U.S.-based companies with a market cap of $500 million or more and total shareholder returns (TSR) in the top 25% for 2020 and 2021. The companies were in the health and life sciences, consumer products and retail, and technology industries. Within this group, EY narrowed the search to include only those that communicated specifics about their capital allocation strategy by sharing useful details instead of a generic discussion. 

  Akhilesh Kulkarni

In reviewing press releases and transcripts of earnings calls and conferences for 61 companies, we found that fewer than one in four included specifics about capital allocation strategy. There also appeared to be a gap between CFO perception and practice: In the EY 2021 Global Capital Allocation Survey, more than half (55%) of CFOs indicated they communicate their capital allocation strategy to the investor and analyst community.  

Beyond Generalities

We identified companies in each industry that offered discussion around the common factors of debt, dividends, and share buybacks. But very few took it a step further by demonstrating what we consider to be leading practices for shareholder communications:

  1. Providing details on a broad range of initiatives covering mergers and acquisitions (M&A), research and development (R&D), and other capital expenditure (capex) strategies, in addition to share buybacks, dividends, and debt discussion

  2. Quantifying plans with numbers and specific details, such as thresholds used for prioritizing capital allocation decisions and guidance on the amount allocated to R&D, capex, and M&A

  3. Explaining the rationale behind spending decisions

Real-World Examples

To give CFOs a look at straight talk about capital allocations, we captured quotes from publicly available management discussions and analyst reports for Edwards Lifesciences, Lowe’s, and ON Semiconductor. Those three companies met our analysis criteria based on TSR performance and level of detail in stakeholder communications. 

M&A Strategy: “In the area of M&A, it’s still going to be important as a support for executing our strategy…. And so we’re always looking for new technologies, as well as intellectual property [IP] and experience that we can purchase. We have a pretty disciplined approach to M&A. We’re primarily focused on tuck-in technologies to our existing portfolio of new development programs.” — Scott B. Ullem, Edward Lifesciences CFO, May 2020

Analyst report: “Edwards historically hasn’t been the most active on the M&A front, but management highlighted that its interests would be in pre-revenue structural heart technologies more akin to IP investments, with strategic fit a clear priority over cash-flow generation.” – JPMorgan, December 2021

Linking Capex to Strategy: “We are investing capital, with the focus on expanding our omnichannel capabilities … expecting to spend $1.7 billion in capex …. This includes a significant merchandising investment of approximately $250 million to reset the layout of our U.S. stores … aligned with our goal of increasing the sales productivity in our stores while driving operating margin expansion longer term.” – David M. Denton, Lowe’s Companies CFO, December 2020

Analyst report: “Unchanged (and shareholder-friendly) capital allocation goals. Lowe’s is prudently investing in its core business and technology capabilities with $2 billion of planned capex in ’21 (vs. $1.5 billion in a typical year).” – Morgan Stanley, October 2021

Providing rationale: “R&D investments should be in that 11% to 12% rate, and we expect that we will continue investing in high-growth areas, things like the EFK transfers, silicon carbide, LIDAR, other sensors, more power discrete, industrial IoT, all of those are where we are putting our dollars in for R&D.” – Bernard Gutmann, ON Semiconductor (former) CFO, December 2020

“So the first thing we’re going to continue to do is invest in our organic business for growth. We’re going to invest in product-differentiated and gross margin-accretive products … all of the investments will be ROIC [return on invested capital] based as we think about which choices we have.” – Thad Trent, On Semiconductor (former) CFO, August 2021

Analyst report: “… we think a renewed focus on R&D that provides a bigger bang for every shareholder buck is a step in the right direction….” – Morningstar, February 2021

As these examples illustrate, providing clear and substantive communications about capital allocation doesn’t need to be complicated. CFOs and CEOs who offer their shareholders broader discussion, specific details, and rationale behind capital spending can differentiate their companies.

Govind Gupta is EY Americas valuation leader and Akhilesh Kulkarni is senior manager, strategy and transactions at Ernst & Young. 

The views expressed by the authors are not necessarily those of Ernst & Young LLP or other members of the global EY organization.