Apple's Share-Buyback Program Cannot Replace Top-Line Growth

Apple will continue to need robust growth from China to reward investors. Apple store in Beijing. Source: Flickr user Chinnian.

When it comes to Apple (AAPL -0.81%), two divergent camps are developing as to the company's path forward. For unabashed Apple bulls, the thesis that Apple's too reliant on one product -- the iPhone -- and early indications that the overall smartphone market is slowing are overplayed, and won't materialize in the immediate future. A few have even speculated that the company doesn't need to grow revenue in a meaningful way, as a possible combination of free cash flow and earnings-per-share growth -- apparently from more-efficient operations -- and increased valuation multiples will lead to share appreciation.

Bulls have another powerful argument, however, and that's Apple's aggressive share-buyback program that acts as a long put of sorts against falling share prices. And it seems Apple is only getting started enriching investors by buying back and retiring its shares, as the company's buyback program is increasing in scope. However, I think the company still needs to grow its top line to enrich investors.

Apple's amazing stock buyback
When it comes to buying back stock, Apple's scale is simply amazing. During the last two years, the company has repurchased $81 billion of its own stock. For a comparison, Apple's repurchased more in stock than the combined market capitalizations of Tesla, LinkedIn, and Twitter, with a few billion to spare. For a visual representation of Apple's buybacks, see the chart below.

Source: Apple's Statement of Cash Flows. FCF Calculation: Cash from operations-investments in plants, property, and equipment. Dollar figures listed in millions.

Interestingly enough, Apple's share repurchases have mostly been able to be supported by its free cash flow. Free cash flow is simply the cash generated from operations (the selling of iPhones, iPads, etc.) minus the cash paid for capital expenditures like plants, property, and equipment.

Although there are quarters during which the buyback exceeds the free cash flow, during the last two years, Apple's free cash flow exceeded the amount that Apple has paid for shares. And even in the event the share-repurchase program does exceed Apple's free cash flow, the company can utilize its cash pile -- which totals more than $200 billion – or borrow money at low rates from banks aware of Apple's legendary cash pile to buy back more shares.

However, there are two issues with buybacks. Most companies do them poorly, and they are no silver bullet against falling revenue and earnings.

Buying back shares serves as a put of sorts, but hasn't always been done well
Companies buy back shares for many reasons, and it's generally considered a positive sign by investors, but not all share repurchase plans are value-accretive. Perhaps the poster child of an ineffective and value-destructive share repurchase program is IBM (NYSE: IBM). In the last 15 years, the company has purchased nearly $110 billion in shares in an attempt to prop up its EPS and market cap, but has seen its market cap actually fall nearly 40% in that period as investors have grown wary of an operationally struggling company.

And it's not just IBM. Most companies have done poorly at buying back stock. Interestingly enough, companies make the same mistakes as irrational investors, buying back stock when the market tends to be overvalued, and not doing so when their shares are on sale.

Perhaps this is due to the fact that the valuations and prices of stocks are, in aggregate, positively correlated with the economic performance that provides the boost in cash and C-suite ebullience to buy back shares. A smart buyback policy should be negatively correlated with macroeconomic performance -- or to put it succinctly, "you should buy when there's blood on the streets."

Apple's share buyback is picking up, but investors still want growth
Looking at the chart, it seems that the pace of Apple's share buybacks is certainly increasing. Although the $14 billion that Apple repurchased in the fourth quarter isn't the highest total, the six-month figure of $24 billion is a large increase over the first half of the year. Whether Apple will continue this is up for debate, as Apple only has $57 billion left of its capital-return program, a designation that includes dividends.

Personally, however, I'm an Apple bull, and think that the company is undervalued, but I find it hard to accept that investors will suddenly reward Apple with higher valuation multiples after years of not doing so. To expect that to change flies in the face of Keynes' observation that, "the market can remain irrational longer than you can remain solvent." Calling for a change in sentiment is a fool's (lowercase "f") errand. In addition, slowing top-line growth generally has the opposite effect on sentiment -- it generally contracts valuation margins.

Will Apple's top line begin to slow (or even contract)? That's an entirely different question altogether. However, I don't think its buyback policy, or a sentiment change, will save it from slowing top-line growth.