Capex, good or bad?

It depends. Good, generally. Or at least that’d be my assessment. Better, surely, than plowing every last dollar of free cash flow into float-reducing buybacks for the sole purpose of enriching people who don’t need further enriching.

I can hear the shrill protests now: Management teams are beholden to shareholders and that’s just as it should be. Shareholders own the company and they’re entitled to whatever management’s inclined to give them.

That’s fine, but buybacks are in many cases a manifestation of short-termism, and the C-suite’s famously bad at knowing when their own stock’s a bargain. Having a capital “C” in your job title doesn’t a Warren Buffett nor a Charlie Munger make.

This isn’t especially complicated. Assuming there are investment opportunities with a high likelihood of clearing a properly-calculated hurdle rate, the business should pursue those opportunities because as it turns out, the best way to maximize shareholder value over time is to invest smartly in the business to ensure it remains efficient, competitive and all the rest.

When you subjugate those concerns to the so-called “tyranny” of various short-term considerations (e.g., inflating the bottom line for the purposes of reporting season), you’re not doing shareholders any favors. Rather, you’re screwing them in the long run, even if they thank you for it today.

That’s all very basic stuff. The question currently therefore isn’t whether big-tech firms should be investing for future growth, it’s whether they’re over-investing on the mistaken (or overstated) belief that they’ve identified the wave of the future. This is an especially interesting question given that a lot of these companies are traditionally capital light.

With that in mind, have a look at the charts below, from SocGen’s Andrew Lapthorne.

The figure on the left shows capex as a share of operating cash flow for the Mag7 (with Broadcom standing in for Tesla) versus the rest of the index. The figure on the right shows FCF yields broken down similarly.

“Over the past year, [tech] companies have recorded a remarkable 60% growth in capex, six times the rest of the market [and] their combined capex accounted for over 30% of all US non-financial companies’ capital expenditures,” Lapthorne wrote, adding that “in absolute terms, these seven companies spent nearly twice as much as the rest of the market last year.”

The effect of that binge is that the tech mega-caps are no longer capital light compared to the rest of the market. Indeed, some have called the pace of the AI spending spree a “capex bubble.” “Whether this elevated spending represents a one-off or signals a new trend in maintenance capex remains to be seen, but the overall free cash flow yield for these companies has now dropped to just under 2%, leaving limited room for shareholder returns via dividends or buybacks,” Lapthorne went on.

So, I’ll ask again: Capex, good or bad?