Microsoft's Financial Engineering Confirms Fed Stimulus Lives On

Financial engineering has come to dominate corporate performance, and this continues to contribute to the under-performance of the U.S. economy including the slow growth in labor productivity.

Over the past 55 years, corporate incentives have changed to the point where corporations think first about how they can engineer higher stock prices and then later look for ways to invest that money to improve operating performance.

Microsoft (MSFT) provides another example of how a major U.S. corporation functions in such an environment, recently announcing another round of stock buybacks connected with a dividend increase.

These kinds of announcements seem to have become so important to stock performance that they are almost as vital to investors as earnings reports.

Microsoft said that it will buy back up to $40 billion of its stock and raise its dividend by 8%.

These move comes on the heels of another stock repurchase round of the same size that will be completed at the end of this year.

In recent years, Microsoft has spent almost $140 billion on stock repurchases.

The $40 billion plan this time represents about 9% of the total market value of Microsoft's stock at $442.7 billion, which is a big percentage.

Microsoft's stock has risen by 31% over the past year.

The question is whether this increase is due to the company's financial engineering or to the direction that Chief Executive Satya Nadella is taking.

Microsoft continues to perform exceptionally well as its return on shareholder's equity is about 31%, up from an average 26.8% over the previous three years.

As such, Microsoft still qualifies as a company that possesses a sustainable competitive advantage.

But the massive flows of cash that Microsoft generates aren't going into any kind of capital investment but instead into financially engineered outlets.

The whole economy seems to be facing this kind of problem. Businesses aren't investing in capital to expand their operations or to improve labor productivity.

Money is churning around the financial system, supporting other assets and not supporting production. As a consequence, economic growth is miniscule, the growth of labor productivity is almost non-existent, and wage increases are small and primarily due to increases in minimum-wage rates.

The stock buyback and dividend increase are good for shareholders, who aren't generally part of the lower 90% of the income classes, and with the prospects for sustained earnings flow, that will continue to benefit Microsoft investors.

Given the growing popularity of financial engineering, that will continue to support this kind of environment, making investing in Microsoft smart, even if Nadella doesn't achieve all his goals and objectives.

But it isn't the optimal in terms of achieving a more robust economy.

Unfortunately, the Federal Reserve is a major contributor to this environment. And as long as its policy is aimed at underwriting a buoyant stock market, the focus on financial engineering won't cease and capital investment will continue to suffer.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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