Apple (AAPL) bulls are impressive. While few investors think the stocks they hold are overvalued, Apple longs tend to defend the valuation of the company's stock much more than most average traders and investors.
The long case of Apple isn't that complicated. Apple currently trades at less than 11x average estimates of next year's likely earnings, and the company has consistently beaten analyst estimates by a fairly wide margin. Apple has also grown its net income by over 75% a year over the last three years, the company has shown impressive recent growth in China, where Apple now gets nearly 20% of its revenues, and the company still has less than 15% of the domestic PC market, with equally significant opportunities abroad. The fact that Apple is generating around $25 billion a year of free cash flow, and has nearly $100 billion a share on the company's balance sheet, makes the current price to earnings ratio look cheap as well.
While, I, like many, thought that the Apple bandwagon was too big. I was wrong, and Apple shares have nearly doubled since the summer of last year, as the company has consistently showed an accelerating growth rate with its new iPhone 4 launch, and the success of its latest iPad products as well. With a growth rate of over 20%, massive annual free cash flow, and nearly $100 billion in cash on the company's balance sheet, it is very hard to argue that Apple's shares are not moderately to significantly undervalued.
This is why I'm so puzzled by why Apple longs are not questioning the company's latest dividend and share buyback plan. Apple's extraordinarily well-covered announcement of the company's intent to initiate a dividend and buyback plan was interesting. The company announced the intent to pay nearly $10 billion in annual dividends and buy back $10 billion of the company's shares.
What is most interesting to me about the recent announcement is the timeframe of the buyback. Apple announced the intent to buy back just $10 billion of the company's shares over the next 3 years; $3 billion a year buyback plan for a company with a market cap of nearly $600 billion whose shares look moderately to significantly undervalued?
If Apple's growth rate is likely to slow only moderately, if at all, why would a company with nearly $100 billion in cash and the ability to issue nearly unlimited amounts of bonds at very low rates only be buying less than 1% of the company's outstanding shares a year?
To me, this plan makes no sense unless you look at the recent dividend and buyback plan as part of an employee compensation plan. Obviously, Apple shareholders benefit as much as Apple employees when the stock goes higher. Still, most Apple employees have a much higher percentage of their net worth in Apple shares, and many have been paid with back dated options. Under Apple's recent amended shareholder agreement, employees who received backdated call options that may not vest for 5 to 10 years, accrue the value of the dividend in the call each year. This is a very rare filing, and enables Apple employees who are being paid in options that won't vest in some cases for many years to accrue dividend payments made before these options vest.
Now, clearly, if Apple bought back shares and the stock moved higher, Apple employees would benefit as much as they would today from the dividend. Still, buybacks on average provide little to the net value of a company's stocks price over the long-term. If Apple shares are moderately to significantly undervalued today, obviously a buyback would be a far better way to return value to current shareholders than simply giving them cash. However, if Apple's share price fell significantly in the next decade because of a recession or the company's slowing growth, Apple employees with long-term call options would benefit very little, if at all, from a potential buyback program initiated now.
This is the why I question Tim Cook's and the Apple board's recent decision. Clearly, Apple shares are more than likely to continue to move higher in the near-term as the economy improves and Apple's premium growth in the U.S. and overseas markets remains strong. If Apple thinks the company can grow at even 15% over the next 3-5 years, the company's shares are moderately to significantly undervalued, as most current longs maintain. However, even if Apple's growth rate continues to accelerate and its share price continues to move higher over the next couple years, Apple employees with back-dated options would still need the company to maintain its growth rate long into the future to benefit from a buyback program today when these employees' options vest in 5-10 years.
To conclude, while the S&P 500 and its tracking exchange trade fund, SPY (SPY), is up over 20% since its summer lows last year, Apple's stock has outperformed the broader indexes by a fairly wide margin over the last year. However well Apple's management has made many decisions, the recent dividend and buyback plan seem unlikely to offer current shareholders much value. Since Apple clearly has enough cash to initiate a large buyback and dividend plan, it just doesn't makes sense that the company isn't willing to significantly increase its buyback plan. To me, the only answer is that Apple is putting the interests of its employees, who have received large amounts of compensation in back-dated options, over the interests of current shareholders. If Apple's growth rate continues to be even close to the levels its been at in the last three years, shares are significantly undervalued today.
While a buyback plan value to shareholders going out ten years is difficult to predict, it's hard to argue that a dividend has the same value to Apple shareholders as a buyback plan if shares are moderately to significantly undervalued. Apple's management team has made many great decisions in the past, and Cook obviously decided to not receive any dividends on his shares. Still, even the best companies have to balance shareholder and employee interests.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
