What should Apple Inc. (NASDAQ:AAPL) do with all of its cash? This question has been heavily debated ever since the stock began an epic nosedive from $700 per share to around $430 per share over just a few months. Apple has $137 billion in cash and investments, which represents about 34% of the company’s total market capitalization. It’s clear that Apple can’t possibly reinvest all of this cash into its business, and going on an acquisition spree has almost never turned out well for other tech companies. This leaves three options: raising the dividend significantly, a one-time special dividend, or a massive share buyback program.
When buybacks make sense
Share buybacks are not always a good idea. When a company’s stock is overvalued buybacks are a tremendous waste of money. Too many times buybacks have been used to artificially prop up the stock price, with disastrous consequences in terms of shareholder value. But when a company’s stock is undervalued buying back shares is a far better option than paying a dividend. Warren Buffett says it best:
Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.
We have witnessed many bouts of repurchasing that failed our second test. Sometimes, of course, infractions—even serious ones—are innocent; many CEOs never stop believing their stock is cheap. In other instances, a less benign conclusion seems warranted. It doesn’t suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value.
I wrote about Apple Inc. (NASDAQ:AAPL) recently in an article titled “Getting Real About Apple.” In that article I showed that even under pessimistic growth scenarios Apple is worth more than the $430 per share it’s currently trading for. This means that a share buyback program would greatly benefit shareholders, since shares can be bought for far less than they’re really worth. But exactly how much shareholder value could be reaped from such a program?
A massive buyback
Like I’ve said, Apple Inc. (NASDAQ:AAPL) has $137 billion in cash. On top of this the company generated $41 billion in free cash flow in fiscal 2012. For the purpose of this discussion I’ll assume that the current fair value of Apple is $650 per share, which is the low-end of my slow-growth scenario from my previous Apple article.