While there are many other factors, the growth rates of many companies are at least partially explained by the size of a company. In particular, smaller companies often can experience more growth as they evolve from lower bases of market penetration while the growth of larger companies that have saturated their respective markets may experience more headwinds to growth.
In this article we discuss the fundamental performance of market-darling Apple Inc. (TICKER: AAPL). While we continue to be impressed by their growth despite their tremendous size, the recent strategic move to distribute more of their cash flows to shareholders via dividends and buybacks is perhaps indicative of their acknowledgement of these size-related headwinds.
This article first looks at their historical fundamental performance and discusses how their shareholder-focused capital strategy masks some of their recent growth. We then explore a hypothetical bearish no-growth scenario and find AAPL's incredibly strong brand would likely still generate good value for shareholders.
Please note our analyses rely on our core Fundamental Reporting model which addresses several shortcomings we identify with commonly reported figures (e.g., EPS only reflects the benefits but not the costs of stock buybacks). We provided more explanation in both of our previous two articles, but the bottom line is that our Fundamental Reporting model focuses like a laser on the value created for and ultimately retained by shareholders. This approach results in what we believe to be the most comprehensive model of fundamental performance available.
AAPL Inc 10-Year Fundamental Performance
Over the last 10 years, AAPL has created and retained immense value for its shareholders. Our Fundamental Reporting model calculates their growth at over 35% for this trailing 10-year period. Starting with an initial per-share NAV (shareholder equity) of just $1.42, their NAV grew to $20.29 (light blue). Buybacks increased shareholders' ownership interest in the NAV by a further $2.84. Last but not least, they distributed $6.32 in dividends over this 10-year period. This is impressive growth.
As the chart above shows, the growth appears to have tailed off over the last several years. This coincides with their decision to start returning capital to shareholders in the form of dividends and buybacks. The chart below illustrates their fundamental performance over the last 3.25 years (since they began allocating capital to shareholders). Relative to the 10-year chart above, their fundamental growth appears almost stagnant. However, their growth rate over this period was a still impressive 17% (annualized).
AAPL 3-Year Fundamental Performance
On the surface, it might appear as if AAPL's growth rate halved in recent years. However, this is not the case. As we noted in our previous articles, the Fundamental Reporting model's growth calculations are conservative for two reasons. The first reason relates to the fact we do not account for the time value of the dividends. The second reason is relevant to our point here - buybacks effectively make cash disappear while their benefits generally surface in the future with shareholders receiving a larger percentage share of the firm's profits.
In other words, cash distributed from the balance sheet as dividends ends up directly in the hands of shareholders dollar-for-dollar. Each dollar that disappears from the balance sheet is received by shareholders (not including taxes). However, this is not the case with buybacks.
We reverse engineered the impact of AAPL's buybacks and recalculated their fundamental growth assuming they allocated those funds to dividends instead of buybacks. The result is a hypothetical 25% growth rate over the last few years. While this is lower than the growth rate over the trailing 10 years, it is much higher than the 17% figure calculated with buybacks included.
Looking Forward: The (Unlikely) Bearish Scenario
Given AAPL's tremendous size, it is possible they could be reaching a point of market saturation for its existing products. Indeed, their geographical revenue segmentation is not dissimilar to the percentages for global GDP. In Asia, a single digit percentage of global revenue just 10 years ago now comprises more than 30% of their revenue.
If this is indeed the case, then we would likely see a combination of lower overall earnings growth and lower growth-related capital expenditures. Indeed, looking at our estimates of AAPL's growth cap-ex, we observe a significant reduction since Q3 last year - even more rapid than we observed after Q1 2012 after which AAPL's top line and free cash flow growth clearly lost some steam.
In the following, we consider a rather bearish no-growth scenario whereby we assume AAPL saturates its respective markets and turns into a cash cow. Even with little or no growth, we expect their remarkably strong brand would still translate into high margins and return on capital (ROC). Moreover, their size will continue to allow them many economies of scale including pressure on vendor costs.
This discussion relates to an important point Buffett has spelled out many times over the years: businesses with high ROCs will significantly outpace inflation. In the case of AAPL and its remarkably high ROC, this translates into significant value creation for shareholders even if their top and bottom line figures level off. At a minimum, AAPL's brand should be able to pass through inflation (we assume 3%/year). Moreover, the high ROC would still allow them to engineer growth (from the shareholder perspective) via buybacks. We analyze what this would translate from the shareholder perspective by focusing on how dividends would be impacted.
So what would the dividends look like in this bearish scenario? Based on the assumptions of flat top and bottom lines as well as a 50/50 split in capex (growth/maintenance) we simulated four trajectories for AAPL's dividends. Each trajectory was determined by reallocating growth capex into various combinations of dividends and buybacks. To be conservative, we also assumed valuations would steadily rise making the shares more expensive and thus reducing the benefit of future buybacks.
The table below indicates the percentage breakdown of distributable cash flows allocated between dividends and buybacks (after maintenance cap-ex) and estimates the resultant current dividend yield and growth rate of the dividend over the following 10 years.
Simulated Dividend Trajectories (current yield and growth)
|Trajectory||Dividend allocation||Buyback allocation||Resultant current yield||Hypothetical dividend growth|
To be clear, we are simply pointing out that even if AAPL turns into a cash cow or utility, its impressively high ROC will still allow them to engineer growth for their shareholders. We do not expect growth to disappear immediately as assumed in this bear case analysis.
It is worth noting Trajectory 4 above most closely resembles AAPL's current capital strategy (with an approximate 27%/73% dividend/buyback split). Moreover, AAPL's bearish scenario is similar to the overall market's status quo with the S&P 500 current dividend yield just over 2% and a dividend growth rate between 7-10% since 2000. Given AAPL's bearish no-growth case would effectively result in a market-like profile, this analysis bodes well for AAPL's future stock performance as we find our bearish scenario rather extreme.
More generally, AAPL looks attractive both relative to the market and on an absolute basis on most valuation metrics (e.g., P/E, P/B, P/FCF, Greenblatt earnings yield, etc). Given the stability of cash flows their business generates and attractive valuations, we are eager to see them buy back as much stock as possible (even if financed by borrowing) as it will benefit shareholders over the long term.
AAPL's dividend yield is currently just under 2% but they appear to be growing dividends rapidly. Given they are allocating almost twice as much capital to buybacks as they are dividends, they could rebalance this capital allocation in favor of dividends. This could increase the current yield albeit at the potential expense of future growth (same logic as in the above table but without the bearish assumptions).
As highlighted above, AAPL's past success and market penetration makes its prospects for future growth less compelling - victims of their own success. Indeed, the electronics industry is highly competitive as evidenced by AAPL's slowing iPhone sales. Transitioning to other sectors (e.g., wearables) where the market is wide open involves significant risk.
AAPL only began paying dividends and buying back shares three years ago. While we like their capital strategy (increased focus on allocating capital to shareholders), we cannot be sure how management might react with their capital strategy should they experience a decline in their own business or a more general economic downturn.
Even with its attractive valuation, we find the broad market is currently richly valued. In the case of an overall market correction, AAPL also could decline as babies can get tossed out with the bathwater.
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.