Apple’s Stock Buyback: Savvy, or Anti-Free Market?

Many people in both the public and private spheres have criticized Apple’s use of its massive cash hoard. Public officials (read: Democrats) want Apple to pay more in taxes because, well…they want everybody to pay more in taxes. People in the private sector criticize Apple in many different ways. Two of the most popular criticisms are as follows:

1. Apple should use its cash hoard to create jobs here at home.

President Obama and others want companies like Apple to spend money on hiring folks. Nobody disputes that companies hiring people for permanent jobs would be a good thing. Such hires would help take the heat off of Obama for his economic failures. There are reasons why a company may not want to hire people at this time. More on this below.

2. Apple should use its cash hoard to benefit Apple shareholders.

At the other end of the spectrum, investors such as Carl Icahn want Apple to return money to shareholders in the form of dividends and buybacks.

Bought another $500mil of $AAPL tday, bringing our total to $3.6 billion. If board doesn’t see AAPL’s ‘no brainer’ value we sure do.

— Carl Icahn (@Carl_C_Icahn) January 23, 2014

 

This week, Apple’s CEO Tim Cook announced that it bought back a bunch of shares after the company’s stock dipped post-earnings:

Apple has repurchased $14 billion of its stock in the two weeks after its first-quarter financial results and second-quarter revenue outlook disappointed investors.

Its shares rose in morning trading Friday.

Apple bought $12 billion of the shares through an accelerated repurchase program and $2 billion on the open market, the company confirmed.

Late Thursday Apple Inc. CEO Tim Cook said in an interview with The Wall Street Journal that the company was “surprised” when its stock dropped 8 percent the day after its earnings report and revenue outlook. He told the newspaper he wanted to be “aggressive” and “opportunistic.”

Some criticized Apple’s buyback, saying that it was “emotional” and even “anti-free market.” Jeff Macke at Yahoo! Finance argued that Apple’s buyback was a bad move because (1) they don’t have enough money authorized for buybacks to combat selling pressure for long; (2) the purchases “skewed” the market because they were “inorganic;” and (3) Tim Cook shouldn’t “trade” Apple stock.

Well, respectfully, you’re wrong, Jeff. Apple should do whatever it deems to be proper with its cash hoard, especially including its buybacks. Here’s why:

1. Stock buybacks (and dividends) are usually the best ways to return profits to shareholders.

Shareholders are owners of the corporation. They’re not employees, so they don’t get profit sharing or any sort of money for performance. The only compensation that shareholders get is related to the stock itself. The stock can go up in value, and the shareholders can benefit from appreciation (stock value increasing).

If an investor is invested in Apple for “the long haul,” they may not reap a capital gain from stock appreciation for years or decades. One way that a shareholder can be “rewarded” in the interim is through a dividend.

Dividends can be re-invested. Here’s an example. If Apple is worth $500 per share and pays a dividend as it does now ($12.20 annually, $4.05 quarterly), then at the end of the quarter, each share of apple will be worth $504.05, or 1.0081 shares based on the $500 price. That re-invested dividend will then begin to earn its own dividends, so the next quarter, the stock will be worth $508.13. The re-invested dividends will continue to earn dividends and, over the long term, the value will continue to compound.

Of course, this is a really simply theoretical and it ignores price swings, etc. But you get the idea. And since compounding is the “true” road to wealth, as Richard Russell says, over the long term, it really adds up.

2. Dividends and buybacks cannot be faked.

There’s an old adage I’ll paraphrase here: you can’t fake a buyback (or a dividend). A company can fudge earnings using accounting tricks and holding liabilities off of their balance sheets. It’s unethical and illegal. This is what Enron did for years, and former CEO of Enron, Ken Lay (pictured above) went to jail until he died because of this.

However, when a company pays a dividend, it has to transfer cash to a shareholder. You can’t fake that. Of course, a company can borrow money to make buybacks and dividends over the very short term. Eventually, that credit line will dry up.

Of course, companies can suddenly cut their dividends when times get tough, like many banks did in 2008. But if a company has a long history of making payments at a certain level (and increasing them at a steady, periodic rate), it’s an indicator of a company’s overall health.

3. Buybacks are a way to reward shareholders in a non-taxable way.

This is an interesting concept, discussed here and by Forbes. Stock buybacks are a way to increase a shareholder’s ownership of a company. When a company buys shares back, the total number of outstanding shares decreases. That means each shareholder owns more of the company. It also means that earnings per share will increase, because there are less shares out there. The Forbes article points out that companies that are buying back shares tend to outperform the market as well.

Buybacks are not taxable because there is no actual transfer of shares to the shareholder, and no cash distribution. So this is another way that companies can award shareholders without the Taxman getting a piece of the action.

This is meant to be a short list of some of the benefits of dividends and buybacks.

But what about the concerns stated by folks who want companies to use the money to hire more people?

Well, the uncertainty created by regulations such as Obamacare likely makes companies of all sizes reluctant to hire. Companies will invest in hiring people when profits are to be made, as they should. Companies aren’t going to hire “for the greater good” because companies don’t serve “the greater good.” Directors and executives have duties to the companies to do what’s best for the corporation, not the public at large, and not the government.

Finally, the notion that Apple’s buyback is anti-free market is absolute nonsense. Apple can purchase whatever shares it deems proper. Tim Cook and the Apple Board of Directors thought that Apple shares are undervalued at this price level (around $500). Therefore, it made purchases at that price point. Time will tell if purchasing shares at around $500 was a good idea or not, but I’d be willing to wager that the educated decisions of Apple board members and executives to make purchases at this price point was a smart one, based on what they know about the company. To suggest that a company that purchases its own shares because it sees value in them is “anti-free market” is absurd. Apple is taking advantage of the failure of Mr. Market to assign the proper valuation to its shares. Good for them.

Companies are not prohibited from buying their own stock back, nor should they be. Mr. Macke is right — Apple does not have enough in its authorized buyback arsenal to fully fend off all sellers if they decided to sell the stock rather than purchase it. Therefore, his points seem to contradict themselves. If Apple cannot fend off short sellers for long, it cannot be “distorting the market” with its recent buyback, can it? Most likely, Tim Cook decided to take advantage of the low price of Apple stock to make what it deems to be a savvy investment for the company. That should be commended.

Companies often use their cash hoards for really bad acquisitions. This post is a summary of terrible acquisitions made by tech companies. Isn’t it better for companies to spend money on the company itself, for the benefit of the shareholders, rather than waste it buying other companies? I think so.

[Standard disclaimers apply. I’m no financial advisor, if that’s not obvious. This is just my opinion and it’s not a recommendation to buy, sell, or trade any stock, bond, or other security or investment. Always do your own homework.]

As always, free markets are better markets.

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This week, earnings season continues with a bunch of companies reporting. Janet Yellen will give a speech this week on Tuesday before the market opens. Look for this to be market-moving, as it’s her first speech since becoming Chairman of the Federal Reserve. Retail sales and initial jobless claims will round out the week, with estimates of a slight dip (-0.1%, excluding autos) and 330k, respectively.

Have a great week!