Capital Allocation Evidence, Analytical Methods, and Assessment Guidance

by Michael J. Mauboussin, Dan Callahan, Darius Majd

Capital allocation is a senior management team’s most fundamental
responsibility. The problem is that many CEOs don’t know how to allocate
capital effectively. The objective of capital allocation is to build long-term
value per share.
Capital allocation is always important but is especially pertinent today
because return on invested capital is high, growth is modest, and
corporate balance sheets in the U.S. have substantial cash.
Internal financing represented more than 90 percent of the source of total
capital for U.S. companies from 1980-2015.
M&A, capital expenditures, and R&D are the largest uses of capital for
operations, and companies now spend more on buybacks than dividends.
This report discusses each use of capital, shows how to analyze that use,
reviews the academic findings, and offers a near-term outlook.
We provide a framework for assessing a company’s capital allocation
skills, which includes examining past behaviors, understanding incentives,
and considering the five principles of capital allocation.

75 pages, Paperback

Published October 19, 2016

About the author

Michael J. Mauboussin is Chief Investment Strategist at Legg Mason Capital Management. Prior to joining LMCM in 2004, Michael was a Managing Director and Chief U.S. Investment Strategist at Credit Suisse. Michael joined CS in 1992 as a packaged food industry analyst. He is a former president of the Consumer Analyst Group of New York and was repeatedly named to Institutional Investors All-America Research Team and The Wall Street Journal All-Star survey in the food industry group.

Michael is the author of Think Twice: Harnessing the Power of Counterintuition (Harvard Business Press, 2009) and More Than You Know: Finding Financial Wisdom in Unconventional PlacesUpdated and Expanded (New York: Columbia Business School Publishing, 2008). More Than You Know was named one of The 100 Best Business Books of All Time by 800-CEO-READ, one of the best business books by BusinessWeek (2006) and best economics book by Strategy+Business (2006). He is also co-author, with Alfred Rappaport, of Expectations Investing: Reading Stock Prices for Better Returns (Harvard Business School Press, 2001).

Michael has been an adjunct professor of finance at Columbia Business School since 1993 and is on the faculty of the Heilbrunn Center for Graham and Dodd Investing. In 2009, Michael received the Deans Award for Teaching Excellence. BusinessWeeks Guide to the Best Business Schools (2001) highlighted Michael as one of the schools Outstanding Faculty, a distinction received by only seven professors.

Michael earned an A.B. from Georgetown University. He is also affiliated with the Santa Fe Institute, a leading center for multi-disciplinary research in complex systems theory, and is on the board of directors of Sermo, an online community for physicians."