Apple: 'No Growth,' No Problem

| About: Apple Inc. (AAPL)


Apple has had an exceptional business and investment history.

Today, there are many more concerns about the future growth of the company.

This article demonstrates why a “no growth” scenario might not be as large of an issue as many suspect.

It's well known that Apple (NASDAQ:AAPL) has been an exceptional business and long-term investment over the last few years. The company earned "just" $1.3 billion in fiscal-year 2005 as compared to over $53 billion by 2015. Naturally sales are much higher, with an increasing profit margin, recently initiated dividend and now lower share count. The business has been humming along for some time. In turn, the share price has more or less followed, with annualized gains during the last decade sitting around 25%.

Of course, we all know that trees don't grow to the sky. Or perhaps in the case of Apple, there are a very select few companies that grow to the sky, but we have yet to see one scrape the stratosphere. That is, well above-average growth cannot last forever. As a business becomes larger and larger, it becomes more and more difficult to grow.

Perhaps most to this point was the company's recent earnings release. Apple indicated that it had a record quarter, selling over $75 billion worth of stuff and earning more than $18 billion, but issued second quarter guidance that was below the previous year. Now to be sure, the company still expects to generate substantial sums, but for many, this was a clear indication of a future without growth (or at the very least much more challenged growth).

This seems like pretty bad news on the surface. Here you have an exceptional growth story for many years and now you're starting to see an indication that this story could be a bit more difficult to formulate moving forward. Yet, I'd contend that a "no growth" situation, especially with a much lower share price, might not be as bad as it first appears.

Let's work with some round numbers. Last year, the company earned over $53 billion in profit. In the coming years, analysts still expect solid growth, with total earnings much higher than what they are now. Instead of assuming growth, let's instead suppose the company stagnates moving forward - "only" earning $50 billion per year and surely disappointing a good deal of people along the way.

Over the past three-and-a-half years, Apple has returned $153 billion to shareholders in the form of dividends and share repurchases, which made up a significant portion of total earnings. Roughly 70% of that capital allocated was attributable to share repurchases and the remainder for dividends. As a baseline, you might anticipate a similar split in dividends versus share repurchases (say twice as many funds going towards repurchases), with perhaps a lower total payout ratio.

As an example, if Apple elected to pay out 75% of its profits in the form of dividends and share repurchases, this could mean 25% ($12.5 billion) going toward dividends and 50% ($25 billion) used to retire shares. Here's what that could look like (in millions) over a 10-year period:

Given the company's "mother of all balance sheets," this seems more than reasonable - supposing an extra $12.5 billion worth of wiggle room. That's the start of the "no growth" scenario, looking at a business that is expected to generate the same amount of profits moving forward. The second part is seeing what this could mean on a per-share basis.

Naturally, we don't know what the future share price will be, but for demonstration, let's use the current trailing yearly earnings multiple of around 10. Here's what you might expect on a per-share basis:

This is the sort of thing, in my view, that ought to be interesting. Here you have a stagnating business, but the per-share metrics are increasing year after year. Due to the robust share repurchase program, you'd expect earnings per share and dividends per share to grow by over 5% annually. In turn, you might expect to collect $28 or so in dividend payments to go along with a future share price above $140. Based on a current price around $94, this equates to a total annualized gain of about 6%.

Now certainly this is nothing to text home about (especially in relation to the company's history), but it's not exactly a poor result either. It's the sort of thing that would turn a $10,000 starting investment into $18,000 after a decade. And this is a base case of a stagnating business.

Of course, some might point to the assumed P/E ratio of 10 and cry foul. Fair enough. Yet, it's important to remember that this doesn't have as large of an effect as you might imagine.

If the average P/E ratio went down to say 7, your ending share price would decrease, but so too would your total number of shares outstanding. In this scenario, you would anticipate a total annualized return of about 5% instead of 6%. Or if the average multiple was closer to 15, the number of shares retired would decrease, but the ending valuation would be higher. In this scenario, your anticipated return would be about 8% per annum.

Whatever way you frame it, with a stagnating business and substantial share repurchases, your anticipated returns would likely be in the mid-to-upper single digits. And naturally, if you suspect that the company can grow a bit, your anticipated returns move from reasonable to solid rather quickly.

In other words: "no growth" for Apple the business wouldn't be a huge problem for shareholders. Your anticipated returns wouldn't be as high as they had been, but this is a long ways away from losing wealth.

In order for the long-term Apple shareholder to not get richer through time then, the business would need to start declining and not just stagnating. Which, incidentally, is well within the realm of possibility. You should always consider a wide range of possibilities when partnering with a business.

Of course, completing this negative exercise can also be quite instructive. Even if the profitability declined by 5% annually over a 10-year period, investors could still see 1% to 2% annual gains from the dividend and offsetting share repurchases. In order to "break even" given the assumptions above, you would need to see Apple's earnings decline by about 7% annually, moving towards $26 billion (half of last year's mark) in the next decade. Again this is conceivable, but the idea is get a feel for what has to happen for a long-term investment thesis to go astray.

In short, Apple has had an exceptional business and investment history. Today, the growth picture appears more challenging. As such, a lot of investors have bemoaned the company's future. Yet, I'd contend that things might not be as bad as they appear. Sure, the 20%+ annual returns could be much more difficult to formulate, but that doesn't simultaneously indicate that reasonable gains cannot be had. As illustrated above, if Apple is able to remain stagnant or even grow a bit, solid investment returns can be generated rather quickly.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.