On April 23, 2014, Apple (NASDAQ:AAPL) filed Q2 2014 financial results with the Securities and Exchange Commission. For Apple, the second quarterly period for fiscal 2014 ended on March 29. Apple closed out its Q2 2014 books having banked $10.2 billion in net income off $45.6 billion in revenue. The performance compared quite favorably with the year-over-year quarter, when Apple took down $43.6 billion in net sales and $9.5 billion in Q2 2013 net profits. In all, Apple recently turned in its most successful quarter outside of the holiday season. Wall Street was clearly pleased with the news, as bullish traders promptly bought Apple stock up to $567.77, which also calculated out to an 8.2% gain through the April 24 session.
Apple also reported that it would be splitting its stock later this summer, as somewhat of an adjunct to the earnings news. In most cases, a stock split would have little to no economic ramifications. The proposed stock split for Apple, however, lays the nominal price groundwork for the consumer electronics corporation to be installed as the latest Dow component. As such, long-term investors can leverage yet another effective put, or psychological price floor in Apple shares for alpha, long-term returns.
Stock Split Economics
Again, stock splits are largely cosmetic agreements. The typical stock split is a two-for-one exchange. For example, a smaller investor may own 100 shares of Corporation X that trades for $50 per share. The value of this Corporation X investment would then be $5,000.00. After a 2:1 split, Corporation X would change hands at $25 per share and each shareholder would be given two shares in exchange for every share owned. The smaller investor would then own 200 shares of Corporation X at $25 per share. The value of the Corporation X investment position would still remain $5,000.00, after the split. Corporation X will account for the 2:1 stock split by doubling the amount of shares outstanding, while halving earnings per share, in subsequent financial filings. Price-to-earnings ratios would therefore remain comparable over time.
In a Fall 1995 paper, Aigbe Akhigbe, Jeff Madura, and Stephen P. Zera analyzed the long-term valuation effects of stock splits for the Journal of Economics and Finance. The summary of the paper was somewhat contradictory and misleading, especially when now juxtaposed against Apple. Akhigbe, Madura, and Zera argued that a stock split would precede 11 months of alpha returns, if the original split announcement were accompanied with strong earning results and dividend increases. Apple, of course, did recently telegraph its intent to expand its capital return program. Apple pledged to increase its ongoing share repurchase authorization to $90 billion from $60 billion, while also offering 8% more in quarterly dividend payouts. In all, Apple has promised to return more than $130 billion back to shareholders through buybacks and dividends by the end of 2015. Apple thusly satisfied the first leg of the Akhigbe, Madura, and Zera stock split thesis.
The Journal of Economics and Finance paper, however, indicated that investment returns would typically stagnate 12 to 36 months after a stock split is completed, due to increased transaction costs. Akhigbe, Madura, and Zera apparently rationalized that smaller investors are attracted to low-priced shares, and drive up brokerage costs through feverish trading and heavier volume. The results of the paper, however, omitted the effects of a boom and bust business cycle, which would support a return to mean, in terms of investment performance. Apple is somewhat immune to the regular business cycle, as it generates the lion's share of all profits within the mobile space. All recent research reports out of both comScore (NASDAQ:SCOR) and IDC may verify that the Apple iOS and Google Android duopoly are actually consolidating power above the smartphone and tablet markets.
Apple and The Dow
Apple has already announced a somewhat unprecedented seven-for-one stock split. On June 6, 2014, Apple shareholders will receive six additional shares for each share owned, as of the June 2, 2014 record date. Apple would then begin to trade at the new split-adjusted price on June 9, 2014. Be advised that Apple stock closed out the April 29, 2014 trading session at $592.33 per share. Investors may expect Apple shares to trade for $85, after the looming 7:1 stock split. This nominal change in Apple share price will carry important ramifications, especially with regard to the makeup of the Dow Jones Industrial Average. In recent years, Apple and ExxonMobil (NYSE:XOM) have jockeyed for the "world's biggest corporation" title. For now, Apple operates as the world's most valuable corporation, with $518.1 billion in market capitalization. (#2 Exxon: $436.1 billion in market capitalization)
The Dow, of course, is a price-weighted average, as opposed to the Standard & Poor's 500, which is a market-weighted index. As such, the price fluctuations of Apple ($518.1 billion), Exxon ($436.1 billion), Google (NASDAQ:GOOG) ($350.8 billion), and Microsoft (NASDAQ:MSFT) ($332.2 billion) wield the most influence within the aggregate S&P 500 Index. Alternatively, Visa (NYSE:V), which closed out the April 29 trading session at $202.67 per share, now maintains the heaviest weighting within the Dow 30. At that time, Visa was a $125.6 billion corporation. Still, General Electric (NYSE:GE), despite its $268.5 billion in market capitalization, was of relatively minimal importance to DJIA calculations. GE stock last changed hands at $26.75 per share.
In any event, installing the pre-split Apple as a component stock would have significantly distorted the DJIA towards the consumer electronics brand and an inaccurate assessment of the U.S. economy. Apple shares have traded between a $303.07 and $705.07 price range over the course of the past three years. Again, Apple is likely to trade near $85 per share after the June 7:1 split. At those levels, Apple could replace Intel (NASDAQ:INTC) without jeopardizing the integrity of the Dow Jones Industrial Average. This symbolic move would also parallel the secular shift away from the personal computer and towards mobile devices. Steve Jobs and his Apple legacy have remained at the forefront of this mobile revolution.
The Bottom Line
Again, the ultimate inclusion of Apple as a Dow component may install yet another built-in put within shares. Last February, Tim Cook did accelerate the Apple buyback plan to purchase $14 billion in company stock within two short weeks. At that time, Cook took advantage of a "surprise" 8% January 28 sell-off to get "aggressive" and buy back Apple stock near an average $500.00 share price. Going forward, additional demand for Apple stock is likely to come out of the more than $1 trillion assets managed through Index Mutual Funds. Of this amount, tens of billions of dollars have been put to work within funds specifically designed to mimic the Dow Jones Industrial Average. More active investors, of course, may execute the Dogs of The Dow strategy, where followers systematically purchase component stocks that feature the highest dividend yields.
Perhaps even more important is the fact that Apple closed out its Q2 2014 books with $150.6 billion above a mere $85.8 billion on the balance sheet. The balance sheet did include $8.3 billion in deferred revenue, which would ultimately transition over to the net income statement. Apple, of course, has kept the majority of its dollars overseas, and has actually tapped the bond market to circumvent Federal income taxes. Still, Apple would be left with at least $112.95 billion in cash and investments, if all of these assets were subject to a 25% tax rate. Taken further, Apple would still carry more than $35.5 billion in cash and investments on the books, after paying off tax levies and all outstanding liabilities. At worst, Apple's liquidity position would still calculate out to $40.64 per share. Wall Street traders value the Apple business model at $550 per share, after backing out net liquidity. In effect, Apple stock trades for a mere 12 times current earnings.
A leading financier, such as Carl Ichan, may endorse any decision to back up the truck and load up upon Apple stock as a "no brainer."
Disclosure: I am long AAPL, XOM. 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.