Apple Inc. (NASDAQ:AAPL) investors have been in for a wild ride. As the market hits new highs, Apple Inc. (NASDAQ:AAPL) is finding new 52-week lows.
Some say its because of Apple’s transition to a value stock from a growth name. Others say its the on-going battle with David Einhorn about a preferred dividend straight out of a financial engineering book.
I think it’s just capital allocation, and nothing more.
Where Apple missed
The belief that Apple Inc. (NASDAQ:AAPL) needs huge amounts of cash for investment purposes – primarily to buy new product – is folly. The company best known for the iPhone runs on negative working capital, selling its devices and collecting payments before it even begins to think about paying suppliers.
So much of the cash and securities Apple Inc. (NASDAQ:AAPL) owns are, as far as the business goes, completely dead weight.
More importantly, Apple’s holdings are dragging down the company’s potential performance. Investors should look closely into the latest quarterly report to see what Apple owns.
Here’s a snapshot:
What do you see? Poorly-performing security after poorly-performing security.
A simple allocation shift for a higher valuation
Fixed-income is a drag on investors who want equity exposure. While Apple’s stock price sank in the last six months, the company’s investments failed to keep pace with the rising tide of the equity markets.
Apple Inc. (NASDAQ:AAPL) could make things easier for investors who want equity returns: move money into equities. Let Apple’s cash sit in something more exciting than corporate bonds and mortgage-backed securities. At the end of the day, investors aren’t worried about the cash coming back as much as they’re worried about the company dragging down its business performance because of its poor investment habits.
Moving into equities solves three basic fundamental problems:
1. Increasing the return on the company’s retained earnings, which are currently being invested in low-return securities, dragging down the company while the market is up.
2. Satisfying investors demand for equity exposure without requiring the company to move cash back to the United States. The company’s “hedge fund,” Braeburn, was invented solely for the purpose of allowing Apple Inc. (NASDAQ:AAPL) to invest its overseas earnings in marketable securities without paying taxes to repatriate its building reserves.
3. Hedging out Apple’s cash isn’t easy. The company can make it simple by putting its cash in something like the SPDR S&P 500 ETF Trust (NYSEARCA:SPY), making it ridiculously easy for investors who want a pure-play on the electronics business to hedge out the effects of the company’s investment performance. For each dollar long Apple Inc. (NASDAQ:AAPL), investors will merely have to go short about $0.33 of the S&P 500 through readily available ETF proxies.
Apple’s not alone in interesting uses of its retained earnings or investment pile. Ford Motor Company (NYSE:F) keeps its pension funds in predominately fixed-income investors to serve as a counter to a very cyclical underlying business. But Apple Inc. (NASDAQ:AAPL) isn’t a very cyclical business, and it doesn’t have years upon years of liabilities to pay out. Rather, its a growing electronic’s business holding back its valuation due to capital allocation.
Investors should call for Apple Inc. (NASDAQ:AAPL) to simplify its holdings, at a minimum. Moving the company’s building stockpile of cash – one which could grow to $170 billion by the end of the year – makes perfect sense. There’s no other way to boost the expected return for investors without paying taxes. Investors want a dividend to presumably reinvest in equities. Those who don’t want the exposure can simply short it out.
The article Apple’s Capital Allocation Miss originally appeared on Fool.com and is written by Jordan Wathen.
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