As investors, we’re used to the concept of investing in a business.
With listed companies, this procedure is fairly straightforward: shares are traded on a stock exchange and the process is carried out electronically. All very simple, takes little time and can be executed from the comfort of your own home.
However, how easy is it for a business to invest in itself? By this, I don’t mean share buybacks, but rather reinvesting profits within the business so as to increase its value over the long run.
This issue has been a hot political topic for some time now, with Labour leader, Ed Miliband, making several high-profile comments on reinvestment by one sector in particular: utilities.
Indeed, the utility sector has been investing vast sums in improving and expanding its asset base, as well as making it a whole lot greener. This is not such an easy task, with there being competing demands for the cash flow generated by the operating activities of utility companies.
For instance, shareholders demand a return today in the form of dividends but, with an eye on retirement, what should really interest most investors is to what degree a company is investing in itself. Such investment should, in the long run, significantly increase the value of the company in question.
One company that has been pursuing considerable reinvestment in recent years is Severn Trent (LSE: SVT). Its capital expenditure has averaged £425 million per annum over the last five years, some of which is contributing towards increasing the total asset base so as to increase the value of the firm in the long run.
So, while many investors may wish for Severn Trent to increase its dividends per share (Severn Trent’s dividends per share are forecast to make only modest gains over the next two years, which has irked many shareholders who are concerned about the effect of inflation on their income), it may be more prudent (and more profitable) for the company to focus to a greater degree on reinvestment.
Such a focus may mean a little short-term pain but, as a result of it, shareholders could be retiring a little sooner than expected as the value of Severn Trent grows at a quicker pace over the long run.
> Peter does not own shares in Severn Trent.