Apple Destroys Value Through Stock Repurchase

Stock buybacks are one of the most misunderstood areas of corporate finance.

From anti-capitalism types who rant about how evil buybacks are to CEOs who do them because they think it “helps the stock” to investors who often think they’re more important than growing the company, most common views on buyback are completely warped.

Some companies do buyback very thoughtfully and with discipline. Most don’t, because the CEO doesn’t understand why it matters, and the CFO came through the accounting side and is afraid to admit they don’t really understand capital allocation.

My longer thoughts on buyback can be found here, but today, I want to call out one specific company (you can probably guess which) for committing a fundamental buyback sin.

Stuck on the Buyback Treadmill

But first, a history lesson. I remember back in 2006 & 2007 getting on Prudential‘s case over their buyback strategy. They kept buying back more and more stock at higher and higher prices (see below).

Year	$ Repurchase by PRU	Average Price
2003	$1B	$34
2004	$1.5B	$46
2005	$2B	$65
2006	$2.5B	$77
2007	$3B	$94
2008	$2.1B	$75

Why? Because they were afraid to stop. God forbid, they told the market they thought the stock had gotten kind of expensive. So they threw bad money after good.

I was one of the few people telling them to be price conscious and to slow down. They chose to ignore that. In 2003, they were buying at 1X P/B. By 2007, they were paying 2X.

What happened next? The Financial Crisis. As you can see, they didn’t slow down until second half of 08. They were paralyzed by perception. Surely they thought, if we slow buybacks, we will be showing weakness!

Do you know what happened in 2009? They had to issue $1.25B of new stock at $39 (among other tactics to strengthen the balance sheet)!

Some quick math will show they issued 32M shares in 2009 after buying back – wait for it – 32M shares in 2007.

Except the ones in 2007 cost them $3B. This means they literally set $1.75B on fire! They were not the only gross offender during the crisis, but they were right near the top in the amount of capital they destroyed through buying too much stock at absurd valuations.

The Case of Apple

This brings us to present day Apple. Do I think they’re doing anything as egregious as Pru? No, not by any means, but they’re using the same thought process.

Look at the chart below. The top half is Apple’s annual buyback. Notice how the dollar amount took off in 2018.

That was a reasonable decision. If you look at the bottom half of the chart, you’ll see Apple’s historic P/E. The stock was cheap back then.

But look what happened beginning in 2020. The P/E never saw 20 again and has spend a fair amount of time at (or above) 30.

Did Apple slow buyback in response? Not a bit, sadly.

They are buying hundreds of billions of stock at valuations likely to prove unsustainable. If Apple returns to a 20 or lower P/E, they will likely have overspent by north of $100B.

Why keep doing it? Because they know if they stop, the market might take their multiple down and they can’t have that.

This fails to understand the multiple will come down on its own someday regardless. You can either destroy value trying to prop it up or accept reality and conserve your capital for higher return options.

Opportunity Cost

Some might say “well, sure, Apple is expensive, but buying back the stock beats making a dumb acquisition or letting the cash sit on the balance sheet”. That is straw man thinking.

You don’t have to choose among bad options. You can find some good options. What might those be?

Part of the framework I explained in the prior piece was to compare the IRR of organic growth or M&A to buyback. Now, while we can debate whether Apple is too conservative on new organic opportunities, they certainly aren’t going to find another $50B/yr of organic investments.

OK, what about M&A? Apple is very M&A averse, outside of small deals. Maybe it’s time for that to change?

Surely, they have competence in evaluating budding technologies. Is the cultural risk of “not built here” so great that M&A wouldn’t work at scale? Couldn’t Apple create value putting their branding on other well designed products that don’t know how to market themselves?

It’s a risk, but it’s also a risk being a slow growing company with a now aging technology largely subsidized by the mobile carriers. Let’s file this as a maybe.

Oh, but wait, there’s another opportunity cost! Remember, Apple is an agent for the shareholders. If it can’t deploy the capital better than paying 30X earnings for minimal growth, then it should let the shareholders redeploy the capital themselves.

Alternate Capital Return

Most companies hate returning capital through dividends. Why? No, not because of the taxes. That’s a red herring.

Rather, they hate that dividends only help ROE, not EPS, whereas buybacks help EPS growth, even if you overpay for the stock.

As long as the P/E is less than 1/(interest rate), it’s accretive – ironically, at 30X, buyback is now dilutive vs. keeping the cash and earning 4% a/t. So, even that argument is toast.

If Apple can’t deploy the capital effectively on its own, and even buyback is dilutive to earnings, there is really no good excuse not to pay large dividends.

There is no shame in admitting your valuation is excessive and special dividends are better than buyback. Progressive and Berkley have used this tool well at times and RLI, in particular, has smartly chosen to pay large dividends rather than buyback stock at large multiples of book.

Apple could easily divert $50B/yr from buybacks to dividend. This would be a little over $3/sh which would take the total dividend to $4/yr. Note, that’s still barely a 2% dividend yield.

Given Apple’s slowing growth, a 2% dividend yield is a perfectly appropriate level. They can call them special dividends if they like, so that they can shut them off if the share price fell to a more favorable valuation.

But it’s really plain foolish to keep buying stock at these levels, rather than transform into a blue chip with a solid dividend.

Insurance Aside: MMC & AON

Quick final thought – this exercise should also be undertaken by MMC & AON. They love buying back stock because it offsets the dilution from all their employee options.

But at 16X EBITDA, that is an awfully expensive use of cash. If you don’t want the share count to go up, stop giving so much stock to employees and pay them cash instead. I know that would be bad for adjusted margins, but you can’t fool people with that trick forever.

The point of having a high multiple is to buy stuff at lower multiples. Note, when brokers traded at 10X, they wisely bought stuff trading at 6-8X.

Now, that they trade at 16X, they use it to buy stuff at…16X. It makes no sense!

The days of multiple arbitrage are largely over. Given that, brokers should slow acquisitions and return more capital to shareholders.

Since Marsh and Aon have the same valuation problem as Apple, they should also switch to paying bigger dividends.

It’s kind of atrocious that they each have 1% div yields. Even Gallagher is at 1%. I remember when it used to be 5%!

Until valuations re-adjust, especially for private companies, at least 50% of free cash flow should be going to dividends. Even that probably only gets them just above 2%, but it’s better than paying peak valuations for their own stock and for private companies.

RLI and Progressive have shown that you can switch to dividends when your stock is expensive without hurting your valuation. Marsh, Aon, Apple and others should learn from their example.