Apple Needs Growth, Not a Buyback

Google's market capitalization is skyrocketing not due to share buybacks but due to growth. Apple needs to follow this example.

Feb 2, 2014 at 11:00AM

When Google (NASDAQ:GOOGL) reported its quarterly earnings, the company revealed that it had about $58 billion in cash and marketable securities. Google is far from being as overcapitalized as Apple (NASDAQ:AAPL), and investors seem to have no problems with the fact that Google neither pays a dividend nor has a share-buyback program in place. The best part? Investors don't seem to mind as the stock continues to hit record highs day in and day out. So, what does this mean?

Apple needs growth, not a buyback
Many investors, including Carl Icahn, believe that if Apple were to simply do the International Business Machines thing and focus on driving up earnings per share via share buybacks, that the stock could trade meaningfully higher from here. While a buyback would certainly serve to juice the share price in the near term (as it would introduce buying pressure), this is not how long-term value, particularly in tech, is created.

See, the thing is that investors had no problem with Apple's cash pile while the business continued to exhibit hyper growth rates for its size. Why? Well, with organic growth came organic EPS growth and -- voila -- growth in the share price! Apple need not weaken its balance sheet to juice up the share price and EPS near term (for all investors know, the market could simply reward Apple with an even lower multiple.) It needs to return to real, honest-to-goodness growth.

The iPhone and iPad can do it in 2014 and 2015
The good news is that Apple is likely to launch a pair of "big" iPhones in a bid to expand its high-end smartphone TAM. Even excluding the "new product category" that Tim Cook has hinted at on various calls, Apple's current product lines still have real life left in them, particularly if the company can just gain share at the high-end/high-margin portions. This isn't going to drive super growth, but it'll be good for at least low- to mid-single digit growth over the next few years.

However, for a company the size of Apple, there will need to be the next big thing (isn't this phrase so tacky, now?) in order to drive another leg of growth in a few years -- if it is ever to materialize. There's a lot of speculation of what it could be, but it's important to not get too carried away until the product is announced and the first couple of quarters' worth of sales are booked. Then, if warranted, the stock will be repriced upward if the new products are a hit.

Foolish take
While a gigantic buyback sounds nice, Apple would ultimately end up inflating its EPS but -- since most of its cash is abroad -- would need to take out a pretty hefty amount of debt in order to retire shares. Even in this case, it's not clear if the buyback really would create long-term value, especially if the company is unable to get the revenue growth engine kick-started. However, if Apple is able to get back to hefty revenue growth, then the buyback won't be needed at all.

So, really, Apple needs to follow the lead of its high-growth tech-stock friends like Google and deliver on the revenue growth to drive the share price up. Apple can probably do it, and frankly, the shares do look compelling here if you believe that Apple really will bring about the "next big thing." If not, then all eyes will continue to be on the iPhone and iPad sales numbers.

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Ashraf Eassa has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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