Apple (AAPL 1.27%) has been nothing short of a dream stock over the last few years. The company produced magnificent returns for shareholders while growing its top and bottom lines at a breakneck pace. It also hasn't been nearly as volatile as other tech giants, and it is currently down by just 14.8% from its all-time high.
Apple made major product and service developments in recent years, most notably the successful expansion of AirPods on the product side and Apple Music, Apple TV+, Apple Card, and Apple Pay on the services side. Yet there's another big reason for Apple stock's success you might not have noticed -- its relentless share repurchases.
The immediate benefit of buying back stock is that it reduces the outstanding share count, which boosts earnings per share (EPS) and makes each remaining share worth more. But a seldom-mentioned benefit of Apple's buyback program is that it serves as a budgetary check on the company. Having an expensive buyback program helps Apple avoid the temptation to overexpand and allows it to boost its EPS the easy way. Here's how it works.
Image source: Getty Images.
A primer on FCF use cases
Apple generates consistently high free cash flow (FCF) because it has high margins and makes way more cash than it needs to operate. Companies can use their FCF to pay down debt, pay dividends, buy back stock, or reinvest in the business.
It already has a great balance sheet, so paying down debt doesn't make too much sense for Apple. It pays a small dividend that yields about 0.6% at the current share price. And while it definitely has the cash to raise that dividend, the issue with dividends is that they do not provide the same lasting benefits as stock buybacks. Both the corporation and its investors pay taxes on dividends. And while a dividend payment can provide shareholders with a nice stream of passive income, it needs to be consistently paid and raised to be a core part of an investment thesis.
On the other hand, buybacks reduce the outstanding share count, which boosts EPS, providing lasting benefits to shareholders. If buybacks continue, there will be fewer and fewer shares -- again, a more permanent benefit that grows EPS, unlike a dividend.
There are many cases where it makes more sense for a company to pay a large dividend rather than buy back its own stock. For example, with low-growth businesses, it can be better to return excess FCF directly to shareholders. But because Apple has so much growth potential across different markets, it makes more sense for it to use the majority of its FCF on its buyback program.
A marathon, not a sprint
By spending most of its FCF on share repurchases, Apple can't grow its business as quickly. But the truth is, it doesn't have to.
One big mistake that large companies can make is to expand horizontally into too many markets too quickly, which leaves them vulnerable during an economic downturn. Then, the company often must retrace its steps, reduce its workforce, and cut spending, which leads to a lot of hassle and waste that could have been avoided if growth was more regimented.
Apple's approach to growth is the exact opposite of Amazon's (AMZN -1.64%). The e-commerce and cloud powerhouse famously doesn't pay a dividend and rarely buys back its own stock. Instead, it tries to grow as quickly as possible. That strategy can allow Amazon to take market share faster than its competitors, which worked marvelously for Amazon Web Services. But it has backfired in a big way lately in its e-commerce business, which left the company scrambling to cut costs so that it could return to positive FCF.
Because it lacks extra FCF, Amazon also doesn't have the dry powder to buy back its own stock now, even though the price is down 47% from its all-time high. Apple, meanwhile, has the cash to buy back its stock if it gets unfairly and excessively sold off by the market.
Why Apple stands out from the crowd
In the current tech sector downturn, Apple is one of the few major tech companies that has not meaningfully cut its workforce -- a testament to how well-run it is. By contrast, Microsoft, Alphabet (GOOGL 0.55%) (GOOG 0.74%), Amazon, and Meta Platforms (META -0.52%) have all laid off thousands of people. Like Apple, Meta and Alphabet generate a lot of FCF and use a good amount of it to buy back stock. But the two tech giants also used some of their spare cash to overhire and invest too quickly in growth. With Alphabet stock trading down 32% from its all-time high and Meta Platforms down 49%, those earlier buybacks look in hindsight like bad investments.
Apple is unusual because it seems genuinely comfortable with its growth rate. In fact, you could even argue that using more of its FCF to speed up growth would be a wasteful endeavor compared to using it to reduce the outstanding share count. The key takeaway here is that reducing the outstanding share count compounds the value of Apple's efforts for its shareholders by permanently boosting EPS.
Over the last 10 years, Apple grew its diluted EPS by 294% compared to net income growth of 140% because it bought back so much of its own stock.
AAPL Shares Outstanding data by YCharts.
If Apple had used that FCF to try and grow earnings instead of reducing its outstanding share count, it would have needed to earn $158.2 billion in net income in 2022 instead of the $95.2 billion it actually made to achieve the same EPS. This stark difference shows how buybacks have allowed Apple to grow its EPS without relying solely on net income growth.
Apple stock is a buy
Despite the myriad headwinds indirectly and directly impacting Apple's business, the company remains in the driver's seat. It has a massive cash cushion and is well-positioned to benefit from a market downturn by buying back its own stock at lower prices and by taking market share from competitors.
And with a price-to-earnings ratio of 26, Apple isn't too expensive of a stock given the quality of its business.
