Apple Buyback Program: Almost as Important as the iPhone?

Image source: Apple.

For better or for worse, Apple (AAPL 1.51%) investors tend to focus very intently on the iPhone business. To be clear, this attention isn't misplaced. After all, the iPhone long ago became the star of the show, and now generates over 60% of all revenue while driving global growth. Yet, relatively little attention gets paid to Apple's buyback program, which could be almost as important to the company's incredible earnings power as the iPhone.

It goes without saying that there are many gears within Apple's profit machine that contribute to its envious margins. The company wields unrivaled pricing power, negotiates favorable volume pricing on components, and exercises discipline in operational spending, among other things. But after everything is said and done, Apple's net income must be divvied up among all shareholders in the form of diluted earnings per share.

Party like it's 2012
Returning capital to shareholders comes in two forms: paying dividends and repurchasing shares. The magnitude of Apple's overall capital return program is unheard of. After kicking things off in 2012, Apple has consistently and aggressive expanded its capital returns each and every year, with no signs of slowing down. Importantly, Apple has been predominantly focusing on the share repurchase component, as an unqualified vote of confidence in the company's future. Here's how the program's authorizations have ballooned in the years since. These authorizations are meant to be exhausted over multiple years.

Source: Apple.

The reason why Apple's share repurchase program is so important to its earnings power is that Apple is meaningfully reducing its total shares outstanding. Sometimes when companies repurchase stock, investors don't actually benefit because the repurchase activity merely offsets other naturally dilutive events like equity-based compensation to employees. The repurchases are only accretive to earnings to the extent that shares outstanding declines.

Compared to its peak, Apple has retired over 864,000 shares to date and spent $90 billion repurchasing shares. That's larger than the market caps of many well-established companies. Thanks to this ongoing reduction in total shares outstanding, diluted EPS growth continues to outpace revenue growth. As Apple buys out shareholders, its profits are split among a smaller investor base and remaining shareholders enjoy a larger share of net income.

Win-win-win
There is another benefit to Apple's share repurchase program. Since the company wants to avoid repatriating any of its foreign cash reserves due to repatriation taxes, it has turned to the public debt markets as a way to fund share repurchases. In doing so, Apple is able to alter the composition of its capital base. By effectively swapping out equity capital for debt capital, Apple is able to lower its weighted average cost of capital, or WACC, since debt capital carries a lower cost of capital. From a corporate finance perspective, this is a huge win for shareholders.

It may not be a physical product like the iPhone, but Apple's buyback program is incredibly important to future earnings growth as the Mac maker keeps on giving.