Apple’s Share Price has Doubled
Apple shareholders must be very happy with the company’s performance over the past 12 months. The share price has risen 111% since the end of 2018, not to mention the US.3 (£ 2.31) per share the company has paid in dividends over the period. While Apple’s full-year 2019 results won’t be released until the end of January, they generated operating revenue of US.15.6 billion in the third quarter of the year. That translates to about US 6 60 billion a year, or about the same size as Luxembourg’s economy.
If you had invested US.100 in Apple in early 2019, you would have more than doubled your money in just one year. But we also have to look at this from the other side of the market. New investors must now pay more than double the price they would have paid for Apple shares a year ago.
This depends on what I call the stupid investor theory. This states that for a short-term investor to benefit from buying these shares at the beginning of 2019, they must be able to sell their shares to a “stupid” investor now that they have appreciated their value. This buyer will be forward-looking, probably also short-term, trading with the expectation that they will find a third “stupid” investor later willing to pay an even higher price.
The important thing is that this cannot go on indefinitely. And as we will see, there is a reason why it probably can not continue for much longer.
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Shooting stocks, sinking earnings
To see how long you can maintain this pattern, we need to evaluate whether Apple’s performance is sustainable. When you compare operating income for the last four quarters, from the fourth quarter of 2018 to the third quarter of 2019, with the previous four, you are seeing a 10% drop. During the same period, the company’s revenue fell by more than 5%. The main culprits were the drop in sales of iPhones, in a world saturated with smartphones, and a big decline in China, which is the company’s third largest market. Growth companies like Apple Watch and the App Store were not enough to make up for the decline.
IPhone sales are declining. Ferita Rahayuningsih
Why then, was the return of Apple shares so high? The answer is really very simple. In 2019, the company’s financial strategy consisted mainly of repurchasing its own shares, which had the effect of artificially increasing the share price.
In calendar 2019, according to my estimates using Datastream information, the company spent US 7 74 billion to buy 7.6% of its outstanding shares on the open market. That’s more than US.300 million for each of the 250 trading days in the year. Stock buybacks have a very simple mechanical effect: fewer stocks mean higher earnings per share, which increases performance per share, a key metric in a company’s valuation. At the beginning of 2014, when Apple began its large repurchase program, it had 6.3 billion shares outstanding and earnings per share (EPS) of US.5.68. By December 31 2019, EPS was US.12 on 4.5 billion shares outstanding.
Apple calls this “returning money to shareholders.” Luca Maestri, CFO, stated in the most recent financial statement that in the third quarter of 2019:
We also returned more than US.21 billion to shareholders, including nearly US casi 18 billion in share buybacks and US 3 3.5 billion in dividends and equivalents, as we continue on our path to achieving a net cash neutral position over time.
This money was transferred to shareholders, but with two caveats. First, those who sold their shares did so because they left the company or at least reduced their stake; in other words, Apple is rewarding its less loyal investors by allowing them to withdraw money at a high price. That is a strange way to return money to investors, as it discriminates against those who are not selling. Returning money through the repurchase route has the added advantage in some jurisdictions, such as the U.S. and Switzerland, to be more tax-friendly for these investors compared to the more regular dividend route.
Apple’s stock has skyrocketed in recent years
The second caveat is that the company is repurchasing its shares at ever higher prices. For example, while in the last quarter of 2019 Apple repurchased 59 million shares at an average price of US.266, in the first quarter of 2018, the company bought 159 million shares at an average price of US. 171. You start to wonder if Apple is the stupid investor.
The end is near?
Maestri’s quote also puts an expiration date on this strategy. Apple expects to continue buying shares until it reaches a cash neutral position. This is the time when the company’s cash is equal to its debt. As of September 2019, cash holdings amount to US.100 billion and debt stands at US 9 91 billion. The company’s annual cash flow is about US.25 billion a year, which is only about a third of the money spent on repurchases in 2019. Since the gap between existing cash holdings and debt is not close enough to cover the difference, the buyback frenzy is clearly not going to continue.