The Real Game-Changer for Apple in 2014

Apple (NASDAQ: AAPL  ) is putting its abundant financial resources to use lately. The company has repurchased a whopping $14 billion of its own stock in only two weeks, with a positive reaction among many investors. Opportunistic buybacks are the smart thing to do in terms of capital allocation, but the real game-changer for the company would be successful product innovation.

Show me the money!
Renowned activist investor Carl Icahn announced on Monday his decision to back away from his nonbinding proposal that Apple increase its stock buybacks to $50 billion. The news comes after CEO Tim Cook said last week that the company repurchased nearly $14 billion in the two weeks following its latest earnings report, bringing the total buyback amount to more than $40 billion over the past year, so the company is aggressively putting its money to work.

Returning capital to shareholders is the right thing to do, considering that Apple has more than enough money to reinvest in the business and the stock looks materially undervalued at current levels.

With nearly $159 billion in cash and equivalents on its balance sheet, and generating over $22.6 billion in operating cash flow during the last quarter alone, there is no reason Apple should let all that money accumulate in the bank, generating lackluster returns, when it could be allocated much more efficiently by being distributed to shareholders.

The stock is also trading at a P/E ratio near 13 times earnings, a material discount to the average valuation of around 18 for companies in the S&P 500 index. Considering that Apple owns one of the most valuable brands in the world, a rock-solid balance sheet, and an extraordinarily profitable business, this entry price could easily be considered a buying opportunity for long-term investors.

When a company is repurchasing its own shares at a convenient price, it's not only reducing the share count and increasing earnings per share, but it's also putting the company's cash to work in a profitable investment. This is a double benefit for investors, so Cook is being a smart capital allocator by accelerating buybacks while the stock is attractively valued.

Show me the products!
Icahn recently compared via Twitter the valuation multiples the market currently assigns to Apple and Google (NASDAQ: GOOGL  ) , and he reached the conclusion that Apple could trade near $1,245 per share if it carried the same valuation multiple as Google in terms of operating profit.

Google is growing considerably faster than Apple. Tthe search giant announced a sales increase of 17% for the December quarter, while Apple's revenues grew by 6.3% during the same period. Google arguably deserves a valuation premium over Apple, but the numbers still show that Apple has plenty of upside potential from current levels if the company can reinvigorate growth. 

To put things in perspective, Apple is trading at a similar valuation to Microsoft (NASDAQ: MSFT  ) , which carries a P/E ratio of 13.6. However, Apple is a leading player in the mobile revolution thanks to the popularity of its iPhone and iPad products, while Microsoft has missed many of the most relevant trends in the tech industry in recent years, and the company is now trying to turn things around under the leadership its new CEO, Satya Nadella.

The market seems to be excessively pessimistic when it comes to Apple, and that's probably related to concerns regarding the company's ability to innovate without Steve Jobs. Cook has repeatedly said that the company will be entering new product categories in 2014, and this could be a real game-changer for the company during the current year.

Apple needs to prove that it can still create new and innovative products, not only because of short-term financial considerations, but, more importantly, because that would show that the company still has the talent and vision to think outside the box and operate like a disruptive growth player.

Bottom line
Apple is doing the right thing by accelerating its stock buyback at opportunistic price levels, and downside risk seems limited considering the stock's undemanding valuation. However, for Apple to move substantially higher, the company needs to prove it can continue innovating and disrupting. Buying stock back is a smart move, but innovation and disruption are what have made Apple one of the best companies in the world. 

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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 10, 2014, at 11:01 PM, wordjunkie wrote:

    You are correct that Apple needs to prove it can produce new and innovative products. Because without that proof it is no longer the Apple that excited investors. Buybacks and dividends are corporate gimmicks to distract from the fact that innovation is not happening. Google gets valued as an innovative company because it is. Apple does not because it isn't. I've been an Apple fan for nearly 30 years, bought it at $20/share, and made a killing. Those days are over. Apple is, for all practical purposes, just another big blue-chip stock.

  • Report this Comment On February 11, 2014, at 1:14 AM, peto3 wrote:

    #wordjunkie# - what you're saying is utter nonsense. In the first place, Apple's buybacks and dividends are not a "corporate gimmick" but a legitimate way for the company to reward shareholders with the portion of it's retained earnings it doesn't think it needs to execute its program of creating best-of-class innovations and bringing them to market. In the second place, just because Apple hasn't yet announced it's next breakthrough product doesn't mean it won't do so - when it's ready to do so (not when you - or anyone else - thinks it should). Lastly, Google "innovation" is nothing but fumes ...

  • Report this Comment On February 11, 2014, at 7:34 AM, jdmeck wrote:

    At least Apple actually makes something. Google's fate is 100% beyond it's control.

  • Report this Comment On February 11, 2014, at 11:07 AM, twolf2919 wrote:

    @wordjunkie,

    As the author indicated, buybacks aren't necessarily corporate gimmicks - if the stock is being bought back at attractive prices.

    You say Google is being valued as an "innovative" company, because it is. Apple is not, because it isn't. Please define "innovative". Yes, Google is *marketing itself* as innovative, but is it really? Let's look at some examples of their innovations:

    Glass: Google's version of the at least 20-year old idea of augmenting reality (I know it's at least that old, because during my graduate studies at Columbia U., I saw a crude version of "Glass"). The only thing that's really new about Glass is its packaging - but is miniaturization really innovation?

    Self-driving cars: MIT has been working on this for decades.

    Google Voice: a voice-based, anticipatory assistant - not only did Siri really come first, but the whole idea has also been around for ages. The only difference is, once again, miniaturization.

    Meanwhile, Apple comes up with whole new chips & devices, creates whole new ways of manufacturing with new materials, comes up with new communication protocols, puts fast, secure, usable fingerprint sensing in every smartphone it sells (going forward), and integrates all its devices via the cloud.

    What has Google ever done - other than search - that's truly more innovative than Apple?

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