Why Steve Jobs Should Have Listened to Warren Buffett

It's a pretty rare privilege to be able to simply call up Warren Buffett directly and ask him for investment advice. Most people would jump at the opportunity, soak up as much of that Omaha wisdom as possible, and likely follow the Oracle's words to the letter.

Then again, most people aren't Steve Jobs.

On a recent appearance on CNBC, the legendary investor recalled an interesting phone call that he received from the Apple (Nasdaq: AAPL  ) co-founder a few years ago. The hot topic of the time (that still rages on to this day) was what to do with the Mac maker's burgeoning money mountain.

The good old days
It was 2010 and Apple shares were a little over $200 at the time, and Jobs felt that shares were undervalued while Apple's cash hoard continued to burst at the seams. The size of its stash depends on when the phone call actually took place; during the four earnings releases in fiscal 2010, Apple reported cash and investments of $39.8 billion, $41.7 billion, $45.8 billion, and $51 billion, in that order.

That total has now more than doubled (or almost doubled from Q4 2010) to $97.6 billion as of the most recent blowout quarter, with Apple shares crossing the $530 threshold for the first time ever today.

Buffett outlined the four standard tools that any company can do with idle dollars: repurchase stock, pay out dividends, make acquisitions, or just plain sit on it. Clearly, Jobs picked the last choice, with Buffett recalling with a laugh: "He just liked having the cash. It was very interesting to me because I later learned that he said I agreed with him to do nothing with the cash."

Buybacks don't always work
Stock repurchases aim to deliver value to shareholders, but their ability to do so hinges on some pretty critical aspects, and buybacks can easily backfire if not done properly. If management thinks shares are undervalued, then buybacks are typically favorable, but management isn't always spot-on with valuing its company's own shares.

Of course, in hindsight, this looks like a no-brainer for Apple, considering the rally that its shares have enjoyed. But in contrast, look at Netflix's (Nasdaq: NFLX  ) ill-timed repurchase program. For most of last year, it was buying back shares averaging near $222, only to sell those shares back to institutional investors for $70 -- a huge waste of shareholder value.

Netflix management certainly couldn't have predicted last year's precipitous fall, but then again its soaring valuation at its peak makes it hard to fathom that anyone thought shares were undervalued. Meanwhile, Apple's share price has just kept pace with its earnings power, so its P/E multiple never seemed that stretched.

On top of that, buybacks need to actually reduce shares outstanding to deliver value to investors, instead of merely offsetting dilutive equity compensation. Consider Activision Blizzard (Nasdaq: ATVI  ) , whose buybacks over the past several years have helped meaningfully bring down shares outstanding, which is accretive to earnings.

In this case, a repurchase program would probably have benefited Apple shareholders, or at the very least helped mitigate the steady rise of outstanding shares over the past decade.

On the other hand, it's not as if you'll hear complaints coming from any investor who's held on to Apple shares for the past 10 years.

Dividends don't always work
We have a new captain now, and some type of dividend is a possibility under CEO Tim Cook. Although Jobs was never keen on a dividend, Cook has made it clear that discussions are heating up, and many analysts now think a special one-time dividend may be in the pipeline.

I don't mind that Apple has never paid me a dividend, since I know that it's always strategically used its cash to create the best supply chain in the world. On top of that, the initiation of a regular dividend signals to investors that the best growth days are in the rearview mirror, which certainly would be bad news for Apple.

This happened to Microsoft (Nasdaq: MSFT  ) when it initiated its regular dividend back in 2003, marking the software giant's transition from being a growth stock to a value one.

The underlying theory is that a company should pay a dividend if it can't earn more reinvesting its cash into the business, or, in academic terms, if the return from reinvesting in new projects and R&D is less than the required return on equity investors demand.

In other words, it means the company has nothing else better to do with the money.

Why Apple never goes big
Regarding acquisitions, Buffett said of Jobs, "He told me they would not have the chance to make big acquisitions that would require lots of money," which goes hand in hand with why Apple never goes big with acquisitions.

Sure, Apple could buy multibillion-dollar companies, but it never will. With most of Apple's acquisitions tallying up to less than $500 million, Apple has plenty of cash to stick with its current acquisition strategy.

Steve Jobs: an enigma wrapped in a mystery with a side of secrecy
Here's part of their conversation, according to Buffett:

Buffett: I would use it for buybacks if I thought my stock was undervalued. How do you feel about that?

Jobs: I think my stock is very undervalued.

Buffett: Well, what better to do with your money?

Even Buffett is a little boggled why Jobs was so averse to repurchasing stock, considering his conviction that shares were undervalued at the time. Heck, Buffett even wishes he had picked up shares himself back then, despite his general distaste for tech companies -- other than IBM.

There are a lot of things about Jobs that we mere mortals will never understand, and we can add this to the list: calling up Buffett for investment advice and ignoring it.

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Fool contributor Evan Niu owns shares of Apple, but he holds no other position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of IBM, Microsoft, Activision Blizzard, and Apple and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Microsoft, Netflix, Apple, and Activision Blizzard, creating bull call spread positions in Apple and Microsoft, and creating a synthetic long position in Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (13) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 29, 2012, at 12:38 AM, harkvasa wrote:

    Apple has done a good job of generating lot of cash . It is a company that is currently growing at a very fast pace, so to continue the pace and stay ahead of the competition, it is best to use the cash to accelerate the growth.

    Apple can generate huge revenue from China and there is so much potential remains yet untapped there. I think, Apple should open up at least 100 new Apple retail stores in China which can help Apple increase sells by $30 Billion in China in the next 2 years.

    AAPL shares are headed to $1000 per share within 3 years .

  • Report this Comment On February 29, 2012, at 6:56 AM, WindsorSmith wrote:

    Evan Niu wrote "I don't mind that Apple has never paid me a dividend, since I know that it's always strategically used its cash to create the best supply chain in the world."

    Well, I mind. Yes, Apple has wisely used some of its cash to set up a great supply chain, but that expense has barely made a dent in its reserves. Just sitting on profits for years and years is NOT a strategic use of cash, even if Apple has converted much of it to marketable securities.

  • Report this Comment On February 29, 2012, at 9:16 AM, robhammerling wrote:

    aapl needs to spend some cash, this really isn't a question, the question is how. why not:

    1) bring 20billion or so they have kept "off-shore" home and pay the u.s taxes they have been exempt from on that

    2) build a manufacturing facility in michigan to build iphones/ipads

    3) reduce dependence on cheap china labor by 75% or more

    does anyone not believe that the value they will add to their brand will pay for this in spades? paying a big tax bill, putting skilled american labor to work, taking jobs from china, building a state of the art factory. it's a pr pro's wet dream and would make aapl the most beloved american company in history.

    and oh, by the way, they would still have 75 billion or so in cash!

  • Report this Comment On February 29, 2012, at 9:27 AM, secretbonus wrote:

    I'm pretty sure Jobs was not lamenting that decision on his death bed.

  • Report this Comment On February 29, 2012, at 9:44 AM, SpaceVegetable wrote:

    I do think they should use some of their cash to repatriate some manufacturing to the US. However I have no problem with any company keeping their foreign earnings overseas. We're one of the only countries that taxes that money - and we have the 2nd highest corporate tax rate in the world. It would be dumb for them to bring that money home just to be gouged on taxes.

    Besides, corporations don't actually pay taxes. Taxes are a business expense and, like all other business expenses, are part of the cost of goods and services sold. Hence, *we* the consumer pay for corporate taxes in the form of higher prices. Anyone who's ever run a business understands this. I wish more people would grasp it instead of bleating endlessly about those "evil greedy corporations who don't pay taxes."

  • Report this Comment On February 29, 2012, at 11:34 AM, deemery wrote:

    It's -not always about stock value-. What's clear is Jobs was focused on the ability of Apple long-term to produce stuff. If your focus is on stock price, buyback makes sense. If your focus is on production, then the Apple cash for supply chain, etc, makes more sense.

    I for one continue to encourage Apple to ignore short term stock price and even profitability to establish long term value. A huge part of that value the last couple of years has been in Apple's ability to meet unprecedented demand for their products, and I see the bank account as being an ammo chest to continue its ability to scale to meet demand.

  • Report this Comment On February 29, 2012, at 11:50 AM, melegross wrote:

    I've never been a fan of buybacks. I look at the biggest companies who have been doing that, and I don't see their stock price having risen because of it. Indeed, most of those companies have seen their stock price drop.

    The idea of equity per share is meaningless. Share price means much more.

    While I would personally like to get a dividend from Apple, I wonder if that would help the company itself. I doubt it. It's not as though my return since mid 2094 has been disappointing.

  • Report this Comment On February 29, 2012, at 11:51 AM, melegross wrote:

    Oops! Of course I meant 2004. Didn't catch that until I hit post.

  • Report this Comment On February 29, 2012, at 2:20 PM, SkippyJohnJones wrote:

    The stock price is 2.5x-ish times what it was in 2010. Who knows what it would have done in the event of a buyback, but we can say for certain that they wouldn't have the amazing optionality value that $100B presents.

    -Japanese tsunami or Thai floods? Just send money men to the site to literally hand out cash to keep priority on whatever limited production stays online.

    -Planning on going all-flash on every device? Just buy up all excess global capacity for the next 6 months to meet demand and choke out the copycats for a while.

    -Sales growing faster than production can handle? Simply advance the cash to Foxconn to double capacity with new facilities.

    Apple has employed all of these tactics and dozens more just like them, all resulting in continuous production, superior products, and mind-boggling margins. I'm happy they haven't done anything with the money...but now they have $100B IN CASH! Enough already, they can return nearly all future cash flows to investors. They aren't going to buy Facebook or anything crazy like that, so let's just get to the dispensing of cash. I'd love to passively add 3-5% to my position each year through dividend reinvestment, but I'll take it however they decide to do it.

  • Report this Comment On February 29, 2012, at 11:37 PM, funspirit wrote:

    I like this column! Well done sir. Apple still isn't super highly valued, but isn't it due for a breather?

    The other thing Apple has going for it, it seems to be going green-

    http://www.richmakesyourich.com/2012/02/best-buy-lost-in-ama...

  • Report this Comment On February 29, 2012, at 11:39 PM, funspirit wrote:

    shoot sorry, wrong link! This one is on the fool.com also about Apple going green. Sorry for error.

    http://beta.fool.com/funspirit/2012/02/28/green-apple-all-pa...

  • Report this Comment On February 29, 2012, at 11:59 PM, jdwelch62 wrote:

    Bring on the dividends!

  • Report this Comment On March 05, 2012, at 7:43 AM, UncleScotty wrote:

    Yes, robhammerling.......I agree: it would have been appropriate for Jobs to have paid his tax bill before cashing in his chips.

    But, who can blame him for never wanting to undergo the rigors of a unionized, confrontational workforce?

    It would have cost the company much more than just the difference in the hourly wage.

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