Monday, March 19, 2012

Apple Initiates Quarterly Dividend and Share Repurchase Program

This morning, Apple (AAPL) announced they will begin paying a quarterly dividend and initiate a share repurchase program.

The company will start paying a $ 2.65/share quarterly dividend and expects to repurchase $ 10 billion of stock over three years.

Using Friday's closing price the annual dividend yield is 1.81 %. Apple will start paying that dividend in the company's fiscal fourth quarter, which begins July 1.

With the stock now hitting all-time highs, it sure would have been nice if the share repurchases had begun much earlier.

The company said the following in their press release about the share repurchase program:

...the Company's Board of Directors has authorized a $10 billion share repurchase program commencing in the Company’s fiscal 2013, which begins on September 30, 2012. The repurchase program is expected to be executed over three years, with the primary objective of neutralizing the impact of dilution from future employee equity grants and employee stock purchase programs.

Apple's stock, even though it has run quite a bit, may not yet be overvalued but saying that the primary objective of the repurchase program is to neutralize "the impact of dilution" is revealing and seems at least poorly worded.

The purpose of a buyback should simply be to buy shares whenever they are comfortably below intrinsic value* for the benefit of long-term holders (as long as the company can easily afford it).

Consider what Apple said in the press release (that the share repurchase program has "the primary objective of neutralizing the impact of dilution") in the context of what Warren Buffett said in the most recent Berkshire Hathaway (BRKashareholder letter:

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 [emphasis added] or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value. The first law of capital allocation – whether the money is slated for acquisitions or share repurchases – is that what is smart at one price is dumb at another.

Apple, like any business, should buy back shares whenever both conditions are met. I think it's safe to say the company has had the first condition covered and, in recent years, it seems pretty clear they've had the second condition also covered (obviously much less so now considering the recent price action of its stock).

In the release, neutralizing share dilution is what Apple said is the primary objective but that's clearly not where the focus should be.

No share repurchase makes sense unless a clear discount to likely intrinsic value exists.

It seems obvious that true long-term investors in Apple's stock don't benefit if shares are repurchased at any cost to meet their stated primary objective. Now, make the primary objective to buy shares whenever they are selling comfortably below intrinsic value and shareholders will do just fine. To me, that's how decision-making for a share repurchase program should be guided.**

With nearly $ 100 billion of cash and investments and that pile of money growing at an extremely rapid clip, it was time for Apple to start returning cash to shareholders. The dividend seems a good start but it will be worth watching closely how their buyback decision-making plays out.

Adam

Established long positions in BRKb and AAPL at less than recent market prices

Related post:
Technology Stocks

* Obviously, intrinsic value cannot be precisely calculated. At best, it's a range that represents a company's likely value. Apple's change in intrinsic value has been unusually fast moving and hard to gauge. It continues to be difficult at best to estimate what's it's really worth and likely going to be worth down the road. The answer now seems likely to be a lot but something this dynamic by its nature has a wider range of outcomes.
** I'm guessing Apple would likely not buy back as much stock if shares became extremely expensive. It's just that the wording of their release doesn't even provide a passing mention of how price versus value impacts their decision-making. Now, if Apple's business continues to be in such good shape it will hardly be the end of the world if they don't get this exactly right. The success of their next several product launches matters a whole lot more. Yet, it is still an example of potentially less than optimal buyback decision-making and capital allocation. Something that has been prevalent with far too many public companies. Who knows, may be Apple will do a good job on this. We'll see.
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