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Apple Should Be Like Berkshire, Put Cash To Real Work

This article is more than 10 years old.

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Well, it’s a start.  I anticipated ten bucks as the right number by year end so we get a $2.65 quarterly declaration from Apple, but is this enough?  Probably not.  On estimated current earning power, $50 a share calendarized, this is a meager 20 percent payout ratio.

Considering Apple’s light ongoing capital expenditures and bare bones R & D outlays, management could amass another $100 billion in free cash flow within two to three years.  So the $10 billion share buyback gambit is a spit in the ocean on a stock pushing $600 billion in market capitalization.  This is under a 2 percent shrinkage offsetting annual options grants.

For technology operators, the deep seated issue is which constituency is favored in capital distributions.  It could be management, employees, shareholders, even their domicile.  When management’s largesse favors themselves and key employees, Wall Street analysts rationalize this obscenity by figuring valuation on non-GAAP rather than GAAP accounting conventions.  Non-GAAP numbers X-out annualized options dilution.

Over the years, mega cap companies like IBM, General Electric, Microsoft, even Exxon Mobil have moved closer to shareholder based gratification.  IBM is the best example where management, years ago, went public with their coherent policy which embraced an aggressive share buyback program as well as rising cash dividends based on earnings growth.

No corporation among the top 25 largest market capitalizations has leveraged its balance sheet like IBM to buy back stock.  IBM has retired over 25% of its stock and reduced earned surplus (where dividends come out of) to a minimal level.

Exxon Mobil pays lip service to returning earnings to shareholders, but its dividend ratchets up modestly as more capital is earmarked for share buybacks.  Meanwhile XOM’s capital spending just equals annual depreciation.  I liked it when recently GE bumped its yield up to 4 percent.  The market took notice.

Corporate America needs to lay out a coherent shareholder return policy that deals with internal capital needs and how committed they are to paying out the excess in cash and share buybacks.  Apple’s maiden declaration is inadequate.  There was no strategic program laid out.  It didn’t deal with the issue of where its $100 billion in liquidity is domiciled and whether dividend policy would be subjected to this limitation.

Would they borrow funds at home if foreign earnings couldn’t be repatriated whole with no IRS levy?  Republicans have made a plank out of this issue in their tax policy pronouncement last week, but if Obama prevails, this is idle chatter.

How much thought have the Democrats given to coaxing earnings repatriation tied to domestic capital spending, R & D, new employee hires and training?  We’ll see.

As for lowering the corporate tax rate, does anyone care that corporations paid much higher tax rates in the sixties and seventies than they do currently?  For investors this is so far passed over.  Should price-earnings ratios for stocks drift down considering a lower tax rate that could reverse under new administrations?

What about Obama’s pronouncement that he wants to see dividends and interest taxed at the 35 percent rate rather than today’s 15 percent?  If this program is enacted, corporations could veer further toward share buybacks rather than cash dividends.  The market’s not going to like such a policy reversal.

It clearly favors management long-term because retirement packages become more valuable at the expense of shareholders.  For years, the chairman of Occidental Petroleum crafted annual bonus packages in the hundreds of millions.  Outside directors hardly blinked.

Finally, the course of the bond market itself could determine whether shareholder friendly dividend and buyback programs have much impact on iconic properties like Apple, Microsoft, IBM, GE et al.  Currently, the magic number is a 4 percent dividend yield for the market to take notice.

Yield stocks turn irrelevant if rates on 10-year Treasuries surge another 100 basis points and 30-year paper breeches 4.5 percent.  Historically, a 4.5 percent yield would still be low in the continuum of financial market history.

Stocks like Merck with a safe yield over 4 percent and the prospect of some modest bump-ups languishes unheralded.  The same goes for Pfizer and Johnson & Johnson.  Even properties like Wellpoint which is up front in terms of major share buyback initiatives still languishes.

The deep basic in all this is that earnings fundamentals for a corporation govern its possibilities to become an above-average stock performer.  Stocks with attractive yields go nowhere if earnings stall out.  Look at AT&T and Verizon.  The earnings payout ratio, while important, is not the pivotal metric.

The overriding metric for determining how much financial engineering a public corporation is capable of enacting is free cash flow.  Stocks should be evaluated on their valuation relative to free cash flow.  A company with a low multiple of free cash flow, say ten is prospectively more attractive than a stock yielding 4 percent with flat earnings and a payout ratio of 70 percent.

Ironically, Apple is a prime prospect for more sizable shareholder largesse.  Capital spending is minimal.  So is its research budget.  Tech properties like Intel spend 15 percent of revenues on R & D, Apple is under 5 percent.

IBM during the eighties pushed itself into serious financial straits by integrating backward into components manufacturing.  Big Blue invested billions and then wrote off semiconductor facilities.  Apple, wisely, utilized Far Eastern independent contractors.

Apple slotted its dividend in the yield bracket with Microsoft, IBM, Cisco Systems and Oracle, between 1.6 and 2 percent.  Steve Jobs abhorred a dividend as thrown out money, sops to unwashed shareholders.  With Apple likely to generate an additional $100 billion in free cash flow, the puzzle of whether this second boodle remains rainy day money, forever, doesn’t solve itself.

I’m at $60 a share in 2013 earnings, but seeing analysts’ numbers ranging from $50 to $80.  The eighty bucks number assumes huge penetration in the China smart phone market.  But Apple has no connection with China Mobile as yet.  As Apple taps lower price point market segments, gross profit margins could be shaded.

So the problem with Apple’s dividend payout tied to earnings is nobody can model Apple’s earning power past next year.  Competitive forces like Samsung and Microsoft, plus issues of market saturation for smart phones and tablets, must surface.  Apple could be a $400 stock on perceived earning power post-2013 of no more than $40 a share.  The ten bucks and change quarterly dividend probably holds but nobody would care.

What’s the right thing to do?  I'd like to see Apple retain all of its accumulated earned surplus and develop a money management cadre to invest its own capital.  Maybe take in outside money as well.  Like Buffett, they’d have to take care to avoid being labeled an investment company and get taxed on earned surplus.

Forget dividends.  Apple should buy Exxon Mobil.  Then, analysts can spend their time on what kind of price-earnings ratio to put on such a mega cap combo.

Outside board members should call the shots.  They whiffed in their initial at bat.  Let’s hope they crush the ball in their next a. b.

-- Martin Sosnoff: mts@atalantasosnoff.com

Martin T. Sosnoff is chairman and founder of Atalanta Sosnoff Capital, LLC, a private investment management company with $8 billion in assets under management. Sosnoff has published two books about his experiences on Wall Street, Humble on Wall Street and Silent Investor, Silent Loser.  He was a columnist for many years at Forbes Magazine and for three years at The New York Post. Sosnoff owns personally and / or Atalanta Sosnoff Capital owns for clients the following investments cited in this commentary: Apple, Google, Microsoft, IBM, Cisco, ExxonMobil, Occidental Petroleum, General Electric, Johnson & Johnson and Pfizer.