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There has been a lot of debate recently about what Apple (AAPL) should do with its $137 billion cash pile. Some investors think the company should issue a big special dividend. Others are hoping for a huge stock buyback. Hedge fund manager David Einhorn is trying to convince Apple's Board to issue perpetual preferred stock. Some even want to see a major acquisition.
Whatever the course Apple decides to take, one thing is certain: that money isn't doing shareholders much good just sitting there.
According to its latest 10-K, 88% of the $137 billion is parked in low yielding marketable securities – mostly in corporate securities, U.S. Treasuries, U.S. agency securities and mortgage- and asset-backed securities "with the primary objective of minimizing the potential risk of principal loss."
Buybacks & Dividends
Deciding what to do with excess cash is a good problem for anyone to have. Apple built up its huge cash balance through years of exceptionally strong cash flow. Even after the company plows back billions of dollars every year to fund future growth, it still generates billions of dollars worth of free cash flow. That's why the company decided in 2012 to start paying out a regular quarterly dividend and initiate a stock buyback.
It's not uncommon for companies to distribute more and more cash to shareholders as they mature. Bigger companies have less growth opportunities, so they plow back less of their earnings into the company and more into shareholders' wallets. And dividends, along with stock buybacks, are the quickest and surest way to return value to shareholders.
When a company actually buys back its shares, it has a direct benefit in that it reduces the number of shares outstanding. This means that earnings are divided among fewer shares. In other words, your piece of the pie just got bigger. If Apple were to spend, say, $75 billion buying back its stock at current levels, it could repurchase approximately 174 million shares, or almost one-fifth of the entire shares outstanding.
However, stock buybacks don't always add value. If a company commences a share repurchase in a stock that is overvalued, clearly that's not a good use of shareholder money. The cash would have been better spent paying a higher dividend, investing for growth, or just leaving it in the bank. Of course, with Apple trading at just 6x forward earnings excluding cash, "overvalued" isn't a word that comes to mind.
But make sure the underlying business is sound before investing in a company that's buying back its own stock, because all the buybacks in the world won't save a company headed off a cliff.
4 Shareholder-Friendly Companies
While I suspect that Apple will announce relatively soon what its plans are for its 12-figure excess cash pile, there are already plenty of shareholder-friendly companies out there generating strong free cash flow, raising their dividends and lowering their shares outstanding by buying back stock. Here are 4 of them:
International Business Machines (IBM)
Free Cash Flow in the Last 12 Months (LTM): $ 15,279 million
Share Buybacks in the Last 12 Months (LTM): $ 11,995 million (79% of FCF)
Dividends Paid in the Last 12 Months (LTM): $ 3,773 million (25% of FCF)
5-year Compound Annual Growth Rate (CAGR) in Dividends: 16%
Note: Since 2005, IBM has generated approximately $112 billion in free cash flow! It has used a whopping $95 billion of that to buy back its stock and has paid $21 billion in dividends for a total of $116 billion. If it hoarded cash like Apple, it would have a ridiculous balance too.
TJX Companies (TJX)
Free Cash Flow LTM: $2,067 million
Share Buybacks LTM: $1,345 million (65% of FCF)
Dividends Paid LTM: $324 million (16% of FCF)
5-year CAGR in Dividends: 21%
Lorillard, Inc. (LO)
Free Cash Flow LTM: $1,096 million
Share Buybacks LTM: $578 million (53% of FCF)
Dividends Paid LTM: $807 million (74% of FCF)
5-year CAGR in Dividends: 12%
Wal-Mart Stores (WMT)
Free Cash Flow LTM: $12,693 million
Share Buybacks LTM: $7,600 million (60% of FCF)
Dividends Paid LTM: $5,361 million (42% of FCF)
5-year CAGR in Dividends: 15%
The Bottom Line
Companies have several options when it comes to deploying their excess cash. These 4 cash machines are choosing to return value to shareholders through generous dividends and big stock buybacks. Apple might want to consider doing the same.
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Disclosure: The author owns shares of IBM and is long AAPL.