Apple (AAPL 1.97%) is about to set a new milestone.

Any day now, the iPhone maker could become the first American company to reach a $2 trillion valuation. Shares of the tech giant have boomed during the pandemic, climbing 56% year to date and 120% over the past year. Apple's devices and services have become essential during the crisis and investors have been bidding the stock higher over anticipation of its 5G iPhones, a rumored subscription bundle, and strong growth in wearables like Airpods and its high-margin services segment, which includes the App Store, AppleCare insurance, and subscriptions like Apple Music and Apple TV+. The company even seems to be getting a tailwind from the pandemic, which has driven increased purchases of iPads and Macs as well as app downloads for things like mobile games.

That bullishness has sent Apple's valuation to levels not seen since 2008. The company's price-to-earnings (P/E) ratio is now 34.9, implying that investors expect significantly higher earnings growth in Apple's future than in the past decade. However, that same multiple expansion that has driven the huge share appreciation directly threatens Apple's biggest source of profit growth -- share buybacks.

The front and the back of the iPhone XS

Image source: Apple.

The EPS delusion

From fiscal 2015 to fiscal 2019, Apple's earnings per share grew by 29% to $11.89, or 6.6% on a compound annual basis, a decent rate for a mature company. However, net income during that time, or the actual profits generated by the business, grew just 3.5% total to $55.3 billion, or 0.9% on annual basis.

In other words, Apple's earnings-per-share growth in recent years has been driven predominantly by share buybacks. Between fiscal 2015 and fiscal 2019, the company repurchased 1.14 million shares, reducing its shares outstanding by 20% and effectively inflating earnings per share by 25%. During those four years, Apple repurchased at least 249 million shares each year, and has spent $237.5 billion on share buybacks over the last five years. By comparison, Apple has spent only about $60 billion in research and development during that time, and made $262.8 billion in net income, meaning virtually all of its profits went to buybacks.

It's clear that share buybacks have been a major priority for the company as a way of growing earnings per share and returning capital to shareholders.

A new challenge

Apple stock has more than doubled in the last year, and its valuation has ballooned along with it. As you can see from the chart below, the P/E ratio is now double, or more, than what was for the last five years. 

AAPL Chart

AAPL data by YCharts

The goal of share buybacks is to repurchase company stock when it is undervalued, but it's hard to say that of Apple stock at this point when its valuation is much higher than at any point in the last decade. Apple is likely to continue repurchasing shares as management seems to have few other ideas for using its profits, and with more than $50 billion in annual net income, it has few other good options. However, those repurchases won't get nearly the same mileage at the current valuation. In order for Apple to buy back 250 million shares currently, it would have to spend more than $110 billion, double last year's profit. 

That means buybacks are likely to slow, which also means that the Mac-maker's earnings-per-share growth potential will be significantly diminished.

All eyes on 5G

With high valuations come great expectations, and investors seem to be betting that Apple's new 5G-compatible iPhone, expected in September or October, will smash previous records, and together with a new services bundle, will lift Apple's profits to the next level. Analysts are forecasting Apple's earnings per share to jump 20% next year to $15.54.

Still, with Apple's P/E ratio now at 35, there are limits to its stock growth at this point, as a 5G supercycle already appears to be priced in.

The more expensive the stock gets, the more difficult it will be for the company to repurchase its own shares, and those limits on share repurchases will slow down its EPS growth. After gaining 86% last year and tacking on another 56% gain this year, increasing by more than $1 trillion in market value, the stock seems fully priced.

At a certain point, any further growth in the stock is going to have to come from an increase in profit rather than multiple expansion on bullish sentiment. After the recent surge, that time looks increasingly imminent.