Is Apple Stock Too Big To Grow?

Apple sells $232 billion worth of iPhones, iPads, iPods, and other merchandise per year. The margins on each item sold are so high that $51.6 billion flows to shareholders as net profits. Buy a $1,300 computer from them? A pure $286 of that will flow go to shareholders as profit that can be used to repurchase stock, fund growth from existing operations, build up the large cash hoard, or do whatever is deemed to advance the interests of the corporation.

It is this enormous size, coupled with the expectations of eventually decreasing profit margins or technological disruption, that have kept the stock’s P/E ratio at a seemingly attractive price point despite 70.5% annual earnings per share growth over the past ten years (and 52.5% annual earnings per share growth over the past five years). As things stand now, Apple earns $9.22 per share and trades at $113 per share, for a P/E ratio of only 12.3x earnings.

I want to address the claim that Apple, due its $232 billion in revenues, is too big to grow. What people are frequently neglecting in their analysis is this: Apple has a low dividend payout ratio and significant cash assets that permit it to follow the ExxonMobil model in which it is not necessary to grow revenues by a substantial amount to deliver good shareholder returns.

Let’s measure Exxon from the date it merged with Mobil in 1999 through the end of the most recent calendar year, 2014. At the time, Exxon made $220 billion in revenues and generated $13.4 billion in annual profits for earnings per share of $1.19.

By the end of 2014, Exxon was generating $364 billion in revenues. It was only revenue growth of 65% over a fifteen year stretch. At first blush, Exxon did seem to be slowed down somewhat by its vast size. But that ended up being almost irrelevant to the ability of Exxon shareholders to experience substantial growth. During this same time, Exxon was only paying out between 25% and 40% of its earnings as dividends (with a few exceptions).

This gave Exxon billions of dollars in profit to repurchase stock each quarter. And boy, did Exxon buy back its own stock. At the time of the merger, there were just around 7 billion shares outstanding (the official tally is the 6.954 billion range). From the end of 1999 through the end of 2014, Exxon repurchased almost 3 billion shares of stock. By the end of 2014, Exxon was down to 4.201 billion shares of stock. About 40% of the stock got retired over these fifteen years while profits also rose.

The net result? Profits of $1.19 in 1999 grew to $7.60 in 2014. The most important thing to know is this: even though Exxon the corporation only grew revenues by 65% from 1999 through 2014, the combination of growing profits and stock buybacks increased the earnings per share by 538%. A similar business model has been executed at Wal-Mart (that is why Wal-Mart shareholders have received seemingly stingy dividend increases the past two years, as Wal-Mart can’t elevate the payout ratio much in stagnant times because it needs to keep those funds available to retire stock).
There is a time, when a stock is truly global and generating hundreds of billions of dollars in revenues, that it needs to repurchase large blocks of stock out of necessity because even vast growth projects would only move the needle by a point or two, and the money can’t all go towards dividends because then the company would be locked in for meager earnings per share growth perpetually from that point onward.

This summer, Apple caught the attention of some investors amidst reports that it was sitting on $200 billion in cash, or roughly 28.6% of the market value. This means that when you buy a $113 share of Apple, you are already laying claim to $32.31 per share in cash. Most of that cash is trapped overseas, and if it were repatriated without a special tax holiday, the true figure would be $21.64 per share. Google and Microsoft are in similar positions, and I imagine this represents some untapped future potential that is often ignored in analysis but can create a lot of additional shareholder wealth in a hurry if deployed correctly.

Apple began following the Exxon Model in 2012. Since then, it has reduced the share count from 6.574 billion to 5.700 billion, for a 13.29% share count reduction in only three years. Going forward, I would look for Apple to deliver 4-6% annual earnings per share gains from the stock buyback alone over the long haul. It can be facilitated by large amounts of profits that are raining down upon Cupertino without much of an offsetting expectation in the form of the dividend.

Apple pays out $2.08 per share in dividends and earns $9.22. That is a dividend payout ratio of only 22.55%. Of the $51 billion that gets sent to headquarters, only $11.5 billion has to go towards shareholders as dividend. This creates a whole lot of leeway for perpetual buybacks. It also develops a symbiotic relationship with the dividend so that hikes can keep coming without having to generate additional cash. What I mean is this: If Apple reduces the share count by 4% next year, it can raise the dividend by 4% and it will only be required to pay out that same $11.5 billion to shareholders.

The risks of technological competition–a new product that can effectively compete with the iPhone–is a much more credible risk and something you should think about thoroughly before buying any shares of Apple. It wasn’t that long ago that Blackberries were the device of choice among the aspirational and upper middle class crowd. This isn’t my preferred business model–I prefer things like Brown Forman, Hershey, Colgate-Palmolive, and Coca-Cola where customers *expect* you to keep churning out the same product over and over again–there is a nostalgia that comes from enjoying the same product at the evolving stages of your life.

The expectations are different at Apple. It must constantly innovate and come up with something new, and if the next iteration disappoints, or someone builds a better mousetrap, the investment returns will be impaired from that time onward. But the size of Apple should not be a concern. The stock only trades at 12x earnings, and there is enormous cash flow to retire a large number of shares at a low cost to purchase each share. It can follow the Exxon Model and deliver earnings per share that greatly exceeds what Apple Inc. sees in the form of revenue growth. There are legitimate concerns about making a buy-and-forget-about-it investment into Apple, but the current size of the enterprise shouldn’t be a deterrent.