Apple Just Invested In Shareholders

| About: Apple Inc. (AAPL)

Apple Inc. (NASDAQ:AAPL) recently presented quarterly earnings and announced plans to increase its dividend to $3.05 per quarter. The company also announced plans to more than double the amount it plans to return to shareholders by 2015, from $45B to $100B.

The Company expects to utilize a total of $100 billion of cash under the expanded program by the end of calendar 2015. This represents a $55 billion increase to the program announced last year...

As part of this program, the Board has increased its share repurchase authorization to $60 billion from the $10 billion level announced last year. This is the largest single share repurchase authorization in history and is expected to be executed by the end of calendar 2015. Apple also expects to utilize about $1 billion annually to net-share-settle vesting restricted stock units.

Shares of Apple jumped nearly $20 after hours, only to give up all of those gains during the earnings announcement. For now, investors are left to wonder if these major capital return initiatives are enough for the share price to pull out of its veritable tailspin.

In the past few months, Apple has experienced a very dramatic fall. Fidelity's Contrafund (FCNTX), one of Apple's largest shareholders, has steadily divested from the company. Apple bulls, who once set price targets near $1,000, have been nearly silenced. Additionally, rogue traders who made huge bets on Apple that failed have caused entire investment firms to shut down completely.

Investors who know Apple from experience should not be surprised. Over the long term, the company has been phenomenal; in the short term, Apple is as wild as a real life bull.

Running of the Bulls

When I wrote about Apple previously, I created a hypothetical portfolio with allocations to Apple, Google (NASDAQ:GOOG), Stanford bonds, MIT century bonds and U.S. Treasuries. The point of the template was to show one possible way to generate income to be able to buy more Apple if investors liked the company enough.

Some could not believe such a strategy would work because they thought Apple would continue to soar, making it too expensive to purchase with income from bonds. It turns out the allocation to Google in my previous article (depending on the portfolio size) would have balanced and outpaced the losses incurred by Apple. Since then, Google has gone up $230 a share and Apple has dropped $180 a share.

No, I am no fortune teller; I am an investor. I have invested in Apple since it was in the low $30 range. I have seen it go up and down, and figured the company's chart appeared similar to many I've seen before; a stock simply does not go straight up forever. Unlike a long-term gradual uptrend in share price, a stock that goes up, nearly vertically to all-time highs, often comes straight back down.

AAPL Chart
(Click to enlarge)

AAPL data by YCharts

However, Apple seems to be different from most other companies. Today's earnings release proved this:

... this is the largest share buyback authorization of any company in history...

First quarter that you're referring to was the largest quarter ever in the history of Apple and the technology industry as a whole.

Clearly, Apple is not ordinary; the company has a massive cash reserve:

... we ended the quarter with $144.7 billion in cash for short-term and long-term marketable securities... a sequential increase of $7.6 billion

Let's take a look at Apple's shares outstanding to get an idea for the impact of the new repurchase plan:

AAPL Shares Outstanding Chart
(Click to enlarge)

AAPL Shares Outstanding data by YCharts

Keep in mind the company announced plans to repurchase up to $60B in stock. Apple's Q2 earnings also revealed 4 million shares have been repurchased and retired recently. So let's look at shares outstanding over a shorter time frame:

AAPL Shares Outstanding Chart
(Click to enlarge)

AAPL Shares Outstanding data by YCharts

In case you are wondering why shares outstanding went up before descending, it is because the number of shares outstanding increases as the company awards stock options. Now, consider the fact that at the current share price of $406, $60B could work out to around 148M shares. If the share price goes down, the company may be able to buy more; if the price goes up, less shares may be repurchased.

As the number of shares outstanding goes down, the price of shares has the potential to go up. However, this depends on the value of the business. Apple products are facing widespread competition, this affects the company's ability to generate profit; in order to pull out of its nose dive, Apple must be innovative, however, thus far the company has lagged on introducing new breakthrough devices.

A Word On Allocation

At this point investors need to remain cautious; many people are making bets on Apple, instead of investing in the company. One key to investing is proper allocation based on portfolio size. In the same way, Apple has a strategy to operate its business; investors require strategies, especially given the volume of buy and sell calls designed to appeal to readers' impulses.

Effectively many reports on Apple either say "sell because the sky is falling" or "buy because this company is about to go through the roof." Instead, I believe it is intelligent to consider:

  • Do I really want to own part of this company?
  • What is a proper allocation?

I try to take these basic criteria a step further, by allocating amounts, that will not irreparably harm a portfolio in the event the sky actually does fall. Additionally, I consider strategies for the event the stock does lose money:

  • If the stock falls, and a loss is incurred, allocate to bonds, and Treasuries that should recoup those losses in the long term

Say an account has lost $5,000 because Apple fell hard. One contingency is to invest in zero coupon U.S. treasuries, for instance.

Yes, the process of recouping the loss may take a long time, however, this can strengthen future investment decisions. The next time an investor thinks of taking a big risk, they will hopefully remember what it takes to attempt to recover possible losses.

The Difference Between Apple Stock / Apple Bonds & Mutual Funds

Recently, I mentioned a mutual fund to an investor who formed an example portfolio, the investor replied:

I'm not sure how I feel about paying fees (no matter how small) for others to manage my money.

My response was:

What you need to realize is, if it is a quality mutual fund... who cares if there is a small expense ratio (keep it to under 1.5% in my opinion) if the fund is making you profit...

Investors simply need to understand the difference between allocating to stocks, bonds and mutual funds. Let's look at $3,000 invested in Apple stock, new Apple bonds that the company announced today (no coupon has been announced yet) and a mutual fund with exposure to Apple:

Apple Stock Apple Bonds Mutual Fund
$3,000 7.5 shares 3 bonds 1 mutual fund

The allocation to stock is pure equity, the allocation to bonds is pure debt and the allocation to a mutual fund could be 5% Apple stock and 95% to different stocks and bonds. If Apple's price skyrockets, of course the stock position will do well. If the stock underperforms, those 7.5 shares could lose several hundred dollars in the near term. The bonds should generate cash every 6 months and return principal at maturity or when called. The mutual fund should be less dependent on the performance of Apple stock, if Apple continues to fall the rest of the holdings have the potential to compensate.

Just last week I invested in a mutual fund for this very reason. It holds Apple and even though the price of the stock sank, the mutual fund went up nearly 1% since I bought it. Keep in mind the overall direction of the market is a very important factor, though I chose a mutual fund that holds several bonds, so I hope the managers will be able to deploy the cash generated successfully over the long run.

Now Let's Look At A Few Mutual Funds & ETFs

One thing to consider is allocating to a company's stock and to a mutual fund or ETF which also holds the stock. Though some people may not find funds as exciting as stocks, the fact is a few strong funds have the potential to generate returns. If you pick some that ultimately generate profit, that profit can be directed wherever you want; such as to Apple stock, or another fund that holds the company.

Though there is an expense ratio, I have found some funds to be worth the cost. For those unfamiliar with finding mutual funds and ETFs that hold their favorite companies, there are two simple ways. One is to search "major holders" of the stock at Yahoo! Finance. The second, and perhaps most comprehensive way is to view "shareholders" at Morningstar.

Keep in mind mutual funds can change their composition at any time, so once you've found one you think looks good, search for the fund's home page. Here are a few of the funds with the largest investments in Apple, in addition to some smaller 4 and 5 star Morningstar rated funds that hold Apple:

Morningstar Rating shares of Apple % invested in Apple stock stocks / bonds expense ratio
Vanguard Total Stock Market Index (NYSEARCA:VTI) **** 12.5M 3.17% 99.5% / 0% 0.05%
Fidelity Contrafund ***** 10.4M 7.3% 98.3% / 0% 0.74%
PowerShares QQQ (NASDAQ:QQQ) ***** 9.1M 11.4% 100% / 0% 0.20%
T. Rowe Price Growth Stock (PRGFX) **** 5.4M 9.4% 98.2% / 0% 0.70%
American Century Fundamental Equity (AFDIX) **** about 19,000 4% 99.1% / 0% 1.01%
Vanguard Balanced Index (VBINX) **** 618,413 1.4% 58.1% / 37.5% 0.24%
Fidelity Balanced (FBALX) **** about 1.4M 2.9% 65.4% / 27.1% 0.60%

Notice two of the funds are balanced funds that hold both stocks and bonds. If you review the Morningstar shareholder page for Apple, you will notice many of the top mutual fund holders of Apple have been selling the stock. In fact, many of the mutual funds that had large positions in Apple last year no longer appear to keep the stock in their top holdings. Therefore it is important to follow the funds and research them if one of the primary reasons for investing is exposure to Apple.

Some of these funds may have reduced their holdings to take profit, while others may have reduced their positions due to fiscal cliff concerns and larger tax consequences announced for 2013. There have also been recent tensions aimed at the company, such as hedge fund manager David Einhorn's demand the company issue preferred shares. Instead, Apple appears to have gone the path never traveled before by initiating the largest capital return program in the history of global business.

Apple is both a great success story and a wild stock to own and follow. Modern technology would not be what it is today if not for Apple's products, yet the recent tailspin is reminiscent of the flight and crash of Icarus. At this point, the share price has returned to the level it was at before Steve Jobs died, after an incredible 70% run-up. Though the price has fallen, the company seems to be more powerful than ever; I believe the company's leadership has proved this and the capital return program is a significant investment in Apple shareholders.

If you have any thoughts on Apple or mutual funds that hold Apple stock, please leave a comment below.

Disclosure: I am long AAPL, VTI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. This article is not a recommendation to buy or sell. Please consult a financial adviser to determine proper allocations for your personal objectives. I am long VBINX, VTI, and FBALX, I may buy or sell Apple stock in the next 72 hours depending on performance, and I am considering Apple's new corporate bonds, when they become available.