Apple (NASDAQ:AAPL), the world's largest company, has just set another record. In the third quarter of this year, Apple completed the largest quarterly share buyback in corporate history. The Cupertino-based company repurchased $16 billion worth of stock, surpassing the $15.7 billion buyback completed by IBM in the first quarter of 2007. This quarterly buyback is just part of the $60 billion of stock that Apple plans to repurchase over a three-year period. The company laid out this plan in late April.
Let's take a look at why this record-setting buyback matters.
Companies buying back stock by the truckload
Apple is not the first company to announce an extensive stock buyback program. Share repurchases have grown increasingly common throughout the financial world over the past couple of years. In the second quarter of 2013, companies increased buybacks by 18.1% year over year to $118.1 billion. According to Standard & Poor's senior index analyst Howard Silverblatt, that's the greatest amount of share buybacks since the third quarter of 2007.
Disney (NYSE:DIS) and Microsoft (NASDAQ:MSFT) have also recently announced extensive share repurchase programs. Disney CFO Jay Rasulo told investors that the company plans to buyback $6 billion to $8 billion worth of stock in the upcoming year, according to Bloomberg. That was prior to Microsoft's announcement of a $40 billion stock buyback program on Sept. 17.
What is responsible for this recent flurry of corporate activity? Companies are cash-rich, with a record $1.14 trillion of cash and cash equivalents sitting on their balance sheets presently. Buying back stock provides a safe and productive method in which this cash can be put to use and benefit shareholders. In addition, stock buybacks are often an attractive compromise for companies, as they are not taking the substantial risk related with dividend increases and acquiring other companies. Furthermore, repurchasing shares, unlike sitting on cash, can reward companies with returns from a rising share price.
Why Fools like you and I should care
Why should investors care? Because by repurchasing stock, companies are reducing the number of shares outstanding. This gives investors a greater claim to the company's earnings. With fewer shares outstanding and a stable earnings number, earnings per share will rise. If the price-to-earnings ratio that the stock trades at remains steady, the share price will rise.
Investors in Apple, Disney, Microsoft, or any other company planning a share buyback program stand to gain.
History even shows that stock buyback programs have been more rewarding to investors than the more traditional dividend increases. The PowerShares Dividend Achievers Fund, which invests in "companies that have increased their annual dividend for 10 or more consecutive fiscal years," has drastically underperformed the PowerShares BuyBack Achievers Fund, which invests in companies that have "repurchased at least 5% or more of [their] outstanding shares for the trailing 12 months."
On a total-return basis, which accounts for dividends, the buyback fund has soundly outperformed the dividend fund:
How to capitalize on this
Just because a company announces a stock repurchase program doesn't mean that its shares will rise in the future. Some companies may announce a massive buyback program and then never follow through. And a buyback program does not necessarily mean that the overall number of shares outstanding will be reduced, as companies often use share repurchase programs to compensate for options programs. In particular, technology companies, which account for 31.5% of all expenditures for buybacks, make frequent use of options programs.
With that said, investors in companies that have bought back their own shares tend to reap handsome gains, as is apparent through the strong performance of the PowerShares Buyback Achievers Fund. If history is any indication of what is to come, stock buybacks should continue to generate significant value for investors. However, these returns will only be rewarded to investors in companies that display impeccable strength in their balance sheets.
What will the effect of these newly announced share repurchase programs be on the stock prices and investors of Apple, Disney, and Microsoft?
For Apple, stock buybacks are a relatively new thing. This current program is the only substantial endeavor the company has made in this space over the past decade, as lately Tim Cook has prioritized rewarding shareholders. Is this program to have a major effect on share prices? Only time will tell, but the program is not likely to have a negative effect on share prices.
Microsoft has made regular use of share buyback programs. However, the programs have done little to take Microsoft shares out of the decade-long rut they have been stuck in.
Disney is somewhere in between Apple and Microsoft in terms of stock buybacks, which have been one of many factors driving the stock higher over the past decade.
The Foolish bottom line
Stock buybacks are becoming increasingly common as companies look to do something with the billions they are currently sitting on. While buybacks may not be sexy, they provide a reasonable compromise between serving shareholders' interests and avoiding too much risk for the company.
And as history shows, buybacks have generated nice returns for investors in the past. Apple, Disney, and Microsoft are three perfect examples of companies that can back their buyback programs with financial strength, and while the magnitude of the impact that buybacks have on companies' share prices is questionable, one thing I am certain of is that these programs will only help investors -- something worth celebrating.
Ryan Guenette owns shares of Apple. The Motley Fool recommends Apple and Walt Disney. The Motley Fool owns shares of Apple, International Business Machines, Microsoft, and Walt Disney. 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.