Steve Jobs Wrong About Stock Buyback Impact

Reports out of the Apple (AAPL) shareholders meeting today are not very encouraging if you are an investor in the company. One of the first questions posed to Steve Jobs during the Q&A session, the first Jobs has attended since his medical leave of absence, concerned the odd decision made by the company to sit on a cash hoard of about $40 billion, earning little or no interest.

Apple has previously taken the position that keeping cash on-hand for acquisitions or large research and development projects made sense. I can buy that for the first $10-$15 billion, but the kind of cash balance held today is not only silly, but a disservice to investors.

So how did Jobs answer when shareholders asked about the possibility of using some cash for a dividend or stock buyback plan? Not well. Jobs said that not only does Apple need to keep that cash for growth opportunities, but even more disturbing, he stated that paying a dividend or buying back stock would not change the stock price.

Given that Peridot Capital has a position in Apple stock, this comment is not only wrong, but it indicates to me that Jobs does not really care about shareholders very much. He is right that paying a dividend would not change the stock price. A dollar of cash is worth the same on Apple’s balance sheet as it would be in the pocket of a shareholder, so any transfer of cash from the company to investors would serve merely as a partial cash out of one’s investment (and would possibly be taxable for the investor).

To assume the same for a share repurchase plan, however, is simply incorrect. Apple could retire 10% of the company’s outstanding shares and only use half of its unused cash balance! How can Jobs argue that a 10% increase in Apple’s earnings per share would not positively impact the stock price? That is exactly why companies use free cash flow to repurchase shares; each investors’ share of the ownership pie increases, which makes each share of stock more valuable.

For those of us hoping Apple would boost earnings by investing its cash hoard more wisely, it appears our voices won’t be heard anytime soon. Unfortunate, but true.

Full Disclosure: Peridot Capital was long shares of Apple at the time of writing, but positions may change at any time

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16 Thoughts on “Steve Jobs Wrong About Stock Buyback Impact

  1. Chad,

    Fact Check: Where did you get $40 billion?
    On the end-of-year balance sheet, it looks more like $24.7 billion in cash and equivalents.

    Jeff

  2. Chad Brand on February 25, 2010 at 3:06 PM said:

    Jeff,
    The press reports were using the round number of $40 billion. Maybe they are including cash and both short and long term investments?

  3. Buybacks, historically have been a boost only in the short term. There is so much of research on this topic. Cash is cash and its use is only seen during downturns.

    Dividend: AAPL is a growth stock and primairly owned by growth funds. Paying a dividend, while shows confidence in their business, also indicates that management feels they have tapped out every possible growth opportunity and the best use of cash is to return to owners, rather than investing in growth. Examples include utilities, telecoms, old tech companies like IBM etc. P/E will get shredded.

    I would have rather preferred to see a 3 or 4 to 1 stock split. While that has no impact to fundamentals, stock can be purchased by retail in size, psychologically it is easier for a stock to go from $50 to $100 rather than $200 to $400.

  4. Heres one non-academic study on impact of buybacks:
    http://www.cfo.com/article.cfm/10316789/c_10313688

    Also, some companies like CSCO have had massive share buyback program for ages – IF the company didnt waste the money on buybacks, conserved it and just held on their balance sheet, stock would not have seen sub-20$ prices during the 2008/09 crash. as mentioned, the advantage of hefty cash is seen/appreciated only during a downturn. All CSCO ended up doing was get a penny beat every quarter in 2005-07 with the massive buyback at elevated prices.

  5. Chad Brand on February 25, 2010 at 6:09 PM said:

    Joe,

    I agree that buybacks only provide a one-time boost, but I’d take a one-time boost than no boost at all.

    I disagree that it is easier for a $50 stock to double to $100 than a $200 stock double to $400. Absolute share price is completely irrelevant to potential share price appreciation.

  6. Achal Agarwal on February 25, 2010 at 8:30 PM said:

    I humbly postulate that Steve Jobs is actually right.

    As an example – consider a firm with $1000 of cash on the balance sheet, and EPS of a $1/sh (and 100 shares)

    The company will be valued, not at $1* PE (say 20), but at $1 * 20 + 1000/100 or $30.

    If I use the cash to buy shares cheaply, say, at $10 / sh, then i can buy all 100 shares, and own a company returning $100/yr, FOR NO COST (using cash on the balance sheet). This is clearly value additive.

    If I use the cash on the balance sheet to buy all the outstanding shares I can at fair value, I will be able to buy $1000/30 shares (33.3). The remaining 66.7 shares, will have ownership of a company with no cash, but earning $100 / yr for a a EPS of 100/66.7 or 1.66. Applying the prior PE of 20x gives a fair value of $30 (as before).

    If I use the balance sheet cash and overpay, then, I will be destroying value.

    I read Steve Jobs as saying that currently, shares are not cheap.

    Finally, note that the above analysis is independent of the starting PE ratio, as long as the buyback does not affect the growth prospects, which in theory it should not unless it adds leverage and impacts the firm’s actions / flexibility.

  7. speculator2001 on February 26, 2010 at 12:05 AM said:

    Achal is correct, repurchasing shares should not change the value of the equity, unless the shares are undervalued. The value should be the same whether the cash is held on the balance sheet, or is given to shareholders via a buyback.

    Buybacks can be used as a signalling tool, and I agree with Achal that the signal Jobs is sending is that the shares are not undervalued.

  8. Chad Brand on February 26, 2010 at 7:40 AM said:

    I guess we’ll have to agree to disagree. Jobs said nothing about the level of the stock, or that his answer was predicated on an overvalued stock. It is very hard to argue that Apple is overvalued (it trades for around 11 times trailing 12 month cash flow).

    I find it hard to believe that if they announced they were using half their cash to buy back 10% of the company that the stock price would remain unchanged. The ROI on a share repurchase plan is certainly higher than cash earning a 1% return in a bank account. Anyway, it doesn’t appear we will be able to prove it one way or another since a buyback is not on the horizon.

  9. Chad,
    Let me give you an example how share split can unlock value. Hypothetically, lets say 1,000,000 sqft of land is put up for sale as one parcel at distressed price of $50/sqft. Obviously it is going to attract few bids as only large companies can afford to write a check for $50mn. However, if they are divided as 2000 sq.ft lots, it is bound to attract much more bids and price would get bid up. The idea behind buyback and/or dividend is unlocking shareholder value/stock is cheap. My point is a stock split can bring more demand for AAPL stock from marginal players/retail, with whom research as time and again showed they are satisfied in owning 100 shares at $50 vs 10 shares at $500, though they are the same.

    If not, can you explain this:
    http://www.google.com/finance?q=NYSE%3ABRK.b and compare it with S&P500 over last 6 months.

  10. Well, the BRK.B chart is not showing up fine, but the point is stock has underperfomed market for 2H09 and broke out post-split.

    this chart shows what i mean:
    http://finance.yahoo.com/q/bc?s=BRK-B&t=1y

  11. Chad Brand on February 26, 2010 at 1:11 PM said:

    Joe,
    Investors who follow Berkshire are well aware that the recent run-up is due to the company being added to the S&P 500. Index funds were buying huge lots of stock, which moved the price up significantly. The stock would have risen regardless of whether or not they split it before it was added to the index.

  12. Chad,
    WOW! So you are justifying that adding to and index can justify 10′s of billions of market cap addition, but stock split wont. I dont have any further comments.

  13. Chad Brand on February 27, 2010 at 2:26 PM said:

    Absolutely. Berkshire is the 4th most valuable U.S. company and yet it wasn’t in the S&P 500! This has been discussed in the press a lot over the last month or so. Here is one of many articles that details exactly how many billions of dollars of BRK stock index funds had to buy. Remember, S&P 500 index fund assets are more than ONE TRILLION DOLLARS.

    http://www.thestreet.com/story/10680675/1/berkshire-sp-500-wedding-day-arrives.html

  14. Chad Brand on February 27, 2010 at 2:36 PM said:

    Here are some data points to illustrate the S&P 500 addition effect. The stock actually dropped after the split took effect, but soared after index funds started buying in droves:

    $69.52 –> BRK.B closing price the last trading day before the split took effect on 1/21 (1/20/2010 closing price)

    $68.00 –> BRK.B closing price the last trading day before the S&P 500 addition was announced (1/26/2010 closing price)

  15. I think that it is very wrong that a company as large as apple would not at least entertain the idea of doing something with all that money, especially in a economy that is fragile to say at best. If it would help out in the smallest way then they should feel obligated to help grow the economy, that has helped them grow, in any way they can. Thats just my opinion anyway.

  16. Well, you are justifying your point using the UNDERLYING THESIS of my point that stock split improves liquidity and attracts more investors. S&P 500 addition IMPROVES liquidity in the stock, attracts more money – positive feedback effect. Both of them have no fundamental bearing, but just improves liquidity and attracts bigger investor base. If AAPL price goes to $75 or $100 post 4 to 1 split, the talk of “use of cash” will automatically abate.

    Rather than doing absolute price movement post and pre announcement, the analysis is better served doing it relative to indices.

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