Apple (NASDAQ:AAPL) has had a strong run up in its stock price over the last few months, clocking a 40% gain since June.
It's price to earnings ratio, a measure of relative value based on the stock price and the company's earnings, has concurrently risen as well. We have recently written on the reasons why Apple should seriously consider freezing or slowing the growth of its dividend; today, we are calling on Apple to end or pullback its stock buyback initiative.
In short, the company is no longer getting a good deal on its repurchases. When Apple was trading at $90/share with a PE around 10, the buyback made a ton of sense. The intrinsic value of the company far outweighed its share price, and the company was getting a great deal. Now, thought, it is nearly 40% higher and is no longer such a good choice to spend billions reacquiring its stock. Instead, Apple should be retaining earnings and deploying cash in efforts to diversify its revenue stream, pay down debt, and fund M&A.
"For continuing shareholders...repurchases only make sense if the shares are bought at a price below intrinsic value. When that rule is followed, the remaining shares experience an immediate gain in intrinsic value. Consider a simple analogy: If there are three equal partners in a business worth $3,000 and one is bought out by the partnership for $900, each of the remaining partners realizes an immediate gain of $50. If the exiting partner is paid $1,100, however, the continuing partners each suffer a loss of $50. The same math applies with corporations and their shareholders. Ergo, the question of whether a repurchase action is value-enhancing or value-destroying for continuing shareholders is entirely purchase-price dependent. "
Notice there is no caveat of "unless the company has a huge cash stockpile" nor a "it's an especially good idea when the cost of debt is low" or even anything about solid free cash flow. No, instead it is rather simple: stock repurchases are a good idea when the purchase price is below intrinsic value, i.e. when it is a good deal. Today, that is no longer the case, and Apple should retain this capital and instead deploy it in other value-generating initiatives. Apple should not merely continue repurchases no matter the price: if Apple wanted to acquire some company, would it take the same approach, that is, pursue it without regard to price? Of course not:
"It is puzzling, therefore, that corporate repurchase announcements almost never refer to a price above which repurchases will be eschewed. That certainly wouldn't be the case if a management was buying an outside business."
What is puzzling is Tim Cook's radio silence on the bargain he appears to believe the stock continues to be as it has risen. We hear lots of boasts about how much Apple has spent buying its own stock (" We've now completed $201 billion of our current $250 billion capital return program, including $144 billion in share repurchases"). But we are left wanting in terms of the future of this program, and whether it still makes financial sense.
It is becoming irresponsible for Apple to continue buying back stock with no guidance or insight into the value shareholders are supposed to be receiving, especially in regards to what else Apple could do with all that money. $144 billion dollars is worth more than the market cap of Tesla (NASDAQ:TSLA), Twitter (NYSE:TWTR), Netlfix (NASDAQ:NFLX) GoPro (NASDAQ:GPRO), and Qualcomm (NASDAQ:QCOM) combined.
Apple continues to generate strong cash flow, even as it has taken on extraordinary amounts of debt to fund its dividend and buyback initiatives. By freezing these capital allocation initiatives, Apple will free up billions in cash that it can use for:
- Strengthening its supply chain - Helping to avoid the need to chase inventory
- Increasing productivity - Accomplishing more with less
- Paying down its enormous debt levels - Apple currently added more debt than cash last quarter
- Innovation in its product offerings - Apple can diversify its appeal to customers, beyond the iPhone or services
- Acquiring strategic "bolt-on" companies - Making accretive moves to diversify its revenue streams or strengthen its process
- Attracting top talent that it has been bleeding to other companies like Google, Tesla, Microsoft, Uber and other start-ups - Ensuring access to the best and brightest
Again, the Oracle of Omaha explains:
"When CEOs or boards are buying a small part of their own company, though, they all too often seem oblivious to price. Would they behave similarly if they were managing a private company with just a few owners and were evaluating the wisdom of buying out one of them?"
How can it be argued that Cook doesn't seem oblivious to a rising price? We are urging serious reconsideration on the continued deployment of billions of dollars that may simply be a bad deal on price.
It boils down to this simple Buffett sentiment that we whole-heartedly agree with: "What is smart at one price is stupid at another."
This idea is likely not expected to be a popular one. But what ramifications are shareholders realistically expected to feel? If CEO Tim Cook took our advice, and announced that rather than raising the a dividend another 10%, it would instead acquire a Skyworks (SWKS( or Nvidia (NASDAQ:NVDA)? That instead of spending billions on buying back stock (now almost 50% more expensive than it was only six months ago) Cook would build a state-of-the-art factory to improve its margins on the iPhone and increase productivity? Would the market truly turn bearish on the stock because Apple decided to focus on the numerator (growing earnings) instead of the denominator (reducing share count) in an effort to grow its EPS?
In fact, we expect the market may cheer such a change in direction, as Apple has long grown complacent on its flagship iPhone. We expect even more, new shareholders if Apple decided to adopt a big growth strategy, rather than just making stock repurchases at a price that simply no longer represents a good deal.
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.