This is a post that I would normally not write, but given the dynamics of how one publicly traded company has such a strong influence, not only on consumers, but the press and especially market indexes, I could not resist. Apple (sym: AAPL) has announced a dividend and stock repurchase for the next three years. What is of most interest is the reduction of float, a nomenclature for repurchasing shares.
What is the significance? By reducing the float (shares available for public trading) the earnings per share increases even if profits remain the same. This provides a good benefit for stock holders. Also, we can with reasonable confidence believe that Apple’s stock is perceived as undervalued by Apple’s management and board members.
Float reduction is a great price manipulation tool. The strategy benefits non-selling shareholders and extracts value from shareholders who sell. If management is accurate in their analysis that the stock is undervalued and they purchase some of the float, they can sell the shares back by reissuing the shares at a higher price, thus making a nice return. The repurchase initiative should provide a better risk return than holding cash. The overall goal will entice institutional investors to become buyers and holders of Apple stock. This will greatly benefit Apple stock holders. Historically, repurchases have allowed stocks to outperform the market by 12-14% for the next 3-4 years.
Given past earnings calls with analysts, Apple’s management have repeatedly expressed strong optimism for their products and markets. This most surely indicated a town crier-like plea for undervaluation. If we look closely at Apple’s financials, the evidence points to a mandatory repurchase due to rapid rising corporate profits. Therefore, the only choice was to buy back shares.
Why dividends? My best guess, according to agency theory, is that Apple needs to issue dividends when cash is relatively large in relation to their valuation. In order to reduce risk in value-reducing investments, (investments in assets that have a higher probability for losing value) management would need to issue dividends. Also, when a company is able to self fund internal projects, the potential to reduce stockholder wealth is greatly increased. By issuing dividends with some excessive cash, companies can reduce risk of poor investments in internal self funded projects.
In summary, Apple has taken the helm in risk management and is looking towards a sustainable business model based on an extremely strong balance sheet. It is very rare for a technology company to exercise prudence. Most companies binge on purchasing performing and nonperforming assets to simulate organic expansion (Google and Cisco). Apple is displaying conservative and long lasting financial responsibilities and should do quite well for it’s stockholders.