Koch Industries Reinvestment Policy of 90% of Earnings vs. Other S&P 500 Companies

What has struck me as interesting is how much Koch Industries reinvests back into their company. The company has a policy of investing 90% of their net income back into Koch Industries. Koch uses their earnings to improve, build, and expand existing capabilities. This reinvestment policy has led to exponential growth which has lead to substantial increase in the amount of dividends of the years. I calculated in this post that Koch Industries increased their dividends by an average of 19% per year (most large companies may increase their dividend 3-4% (if they even increase the dividends at all)). If any public company increased their dividends 19% per year they would be viewed as crazy. However, the question I wanted to look at is how does Koch Industries reinvestment policy compare to other publicly traded companies?

On the surface a company plowing 90% of their net income sounds crazy from a corporate finance perspective. If you plow so much money back into the company how do you manage economic downturns? Companies like to keep a cash or liquidity buffer in case their economic situation weakens. Koch plows back 90% into the company and pays out 7% of its earnings as a dividend leaving about 3% for cash or liquidity needs. In this post I estimated Koch earned $5.6 billion after-tax and if you take 3% of $5.6 billion it would say the cash left over after paying out dividends and flowing back earnings into the company would be only $168 million! Remember Koch Industries has revenues of $100 billion+ of revenue. Since Koch Industries is a privately traded company the company doesn't have to release their financial statements. However, publicly traded companies have to release their financial statements to the public. Also publicly traded companies have to manage quarterly earnings, manage guidance of future forecasts of future earnings with analysts, and if they company pays a dividend manage that as well. Charles Koch isn't fond of publicly traded companies as is quoted as saying (from this 2006 Wall-Street Journal weekend interview) they have "the short-term infatuation with quarterly earnings on Wall-Street restricts the earnings potential of Fortune 500 publicly trade firms".

Although Koch Industries is a conglomerate and is a mix of many different companies. However, from a 2012 interview Dale Robertson mentioned a large portion of the revenue from Koch still comes from energy related things. In analyzing the reinvestment rate of companies I used Morningstar to analyze the 5 year average of the net income and also looked at the capital expenditures of these companies. Analyzing just integrated oil and gas companies (ExxonMobil, Shell, BP, etc.) it appears Koch Industries actually has a more conservative policy than the integrated oil and gas companies. For example ExxonMobil had an average net income of $20.66 billion and their capital expenditures were $23.75 billion. If you divide the capital expenditures by the net income this would get the reinvestment ratio. In the case of ExxonMobil their reinvestment ratio would be 115%. Now you might wonder how can a company plow more income back into the company than it makes? Well companies can borrow money using debt in order to finance their capital expenditures. Looking at an average for ExxonMobil, Shell, BP, and Chevron would show the average reinvestment ratio is 131% which says the integrated oil and gas companies have been borrowing money (primarily due to lower oil prices/also when you are pumping oil out of the ground you have to worry about constant depletion). Koch tries to stay away from debt. Moody's credit rating agency currently rates Koch Industries debt with a credit rating of Aa3 which is high level credit with a stable outlook. The Chief Financial Officer Steve Feilimer has said that Koch Industries can never have AAA credit (the best credit rating) since the company is not publicly traded.

If you compared it to other companies in the Standard & Poor's 500 tells a different story (using a 5 year average from Morningstar) of their reinvestment policy vs. Koch Industries. Apple who makes iPhones, iPads, and other iProducts reinvests 25% of their net income back into the company. The conglomerate Proctor and Gamble plows back 35% of their earnings back into the company while mega conglomerate Berkshire Hathaway run by mid-westerner Warren Buffett reinvests 50% of their profits back into the company. Investment banking company Goldman Sachs reinvests 35% of their net profits. The best comparison of Koch Industries would be a mix of an integrated oil and gas company (it should be noted that Koch Industries does not explore for oil-however is involved with the refining and the process of taking crude oil and using that to develop other products)/a company such as Proctor and Gamble (given Koch produces so many consumer products)/and perhaps Goldman Sachs (Koch has Koch Equity Development which lends and provides financing for other companies). If you took a weighted average and said Koch is 1/3 the average of the integrated oil and gas industry, 1/3 Proctor and Gamble, and 1/3 Goldman Sachs it would lead to a 66% reinvestment ratio. Again Koch reinvests 90% of their net income back into the company which is substantially more than their publicly traded peers.

According to a 1994 Wichita Eagle article in 1966 (the year before Fred Koch passed) Koch Industries earned $166 million of revenue (the company only had 650 employees at the time) and the company only paid out $300,000 in dividends (according to Sons of Wichita). According to Sons of Wichita during the early 1980's the total dividend pool for Koch shareholders was $28 million. Charles Koch grew Koch Industries dramatically by pushing back 90% of the net income the company earned into the company. This historically high reinvestment ratio is much greater than many large Fortune 500 companies.  Today, Koch Industries is a $100+ billion company and I estimated pays out between $380-$940 million in total dividends to shareholders (this estimate is closer to the higher end given testimony from Preston Marshall in a recent court case). This would say that the dividends are now over 3,000 times the amount after Fred Koch passed! The strategy of reinvesting a large amount back into the company has increase the revenues, dividends, and increase the net worth of Charles and David Koch along with the Marshall family. Although, the policy of reinvest 90% of their earnings back into the company may seem crazy for most public companies Koch has shown that this can be sustained for the long term.