Earlier this week, Apple Inc. (AAPL) announced during its quarterly earnings report that it plans to spend $100 billion of its $260 billion + cash hoard on stock buybacks. That’s a huge number, following up on the $23.5 billion it had already spent in the first quarter. The things is, AAPL isn’t the only company that is spending billions of dollars of their liquid assets on share repurchases; a recent report indicates that companies listed in the S&P 500 index are planning to spend about $800 billion through all of 2018. That’s an increase of a little more than 50% over the $530 billion that were spent in 2017.
What are the drivers for such a big surge, and why should you pay attention to them as an investor? Since the beginning of the year, CEOs have indicated that big portions of the tax savings realized as a result of the December 2017 Trump tax cuts will go to buying back their stock. Many of these large-cap companies have already begun seeing major cash inflows as a result of a reduced tax rate, and so they are naturally trying to identify ways to put that money to best use.
Why use stock buybacks, as opposed to investing cash in other business-building activities like research and development, acquisitions and mergers, or debt liquidation? For publicly traded companies, there is a fine balance they are all looking to strike, between using their capital to build and grow their business, while also actively looking for ways to return value to their shareholders. In the long run, things like R&D, acquisition and expansion should help boost the value of shareholder’s ownership, of course; but there are also other activities, like dividend payouts and stock buybacks, that can provide a nearer-term benefit to shareholders, and to which the market tends to respond very favorably.
In the case of AAPL, here’s a pretty simple way to look at it. As of the close of today’s market, AAPL closed a little below $184, and they currently have about 4.9 billion shares outstanding. Shares outstanding is the number of shares that are out there, available to be bought and sold in the market by any investor, large or small. If AAPL bought $100 billion worth of their stock at today’s closing price, it would reduce the number of shares outstanding by about 550 million shares, or to around 4 billion. That’s a reduction of a little over 10% in the total number of shares that are available for public trading. All things being equal, lowering the number of shares outstanding does the same thing to a stock price that reducing the supply of any item you could purchase in a department store does: it pushes the price higher, because you have the same number of people competing for fewer available shares. So the first reason that a company decides to initiate a buyback is because it provides a direct benefit for shareholders, as it will generally help push the stock price higher by a proportional amount to the size of the buyback.
A secondary, but hardly insignificant reason companies buy back their own stock is just as simple as the reason any investor chooses to buy a stock: they are looking for ways to put their liquid assets to work for them, and they think the stock will be worth more in the future than it is today. A simple method for forecasting a company’s ability to grow their business is to look at how much they have grown in the past year. AAPL’s earnings grew about 30% last year, and if they can maintain that pattern of growth, their business next year should be worth about 30% more than it is now. If AAPL’s board considers that forecast against the amount of their planned share repurchase, they could be looking at a $3 gain for every $1 worth of stock they buy back. At some point in the future, they will be likely to sell those shares back to the market just as any investor does, and so in this sense a stock buyback is just one more way a company’s management team can put its liquid assets to effective use.
As already observed, AAPL is hardly only company that is using tax savings and other cash assets to buy back shares of their stock. Here’s four other S&P 500 Index-listed stocks that are spending at least $10 billion or more to do the same thing.
AMGN is planning to spend $10 billion in 2018 alone on stock buybacks, which is a little less than 10% of their total market cap as of today’s market close. Reducing their shares outstanding by about 10% also matches the 10% their earnings grew in the past year; but where AAPL’s stock price has been driving to new highs this week, AMGN’s price is a bit more depressed, having dropped about 15% from its January high at nearly $200 per share. Bear markets and downward trends push stock prices down to levels that the underlying company often begins to believe is a bargain value, and when that happens stock buybacks become more common for the same basic reason already outlined. The upside for AMGN may not be quite as high as with AAPL, but a 10-15% likely return on the $10 billion they’re planning to spend certainly looks better than what they would get by leaving that money in cash, drawing simple interest.
PepsiCo Inc. (PEP)
PEP has announced their intentions to spend about $15 billion on buybacks in 2018. PEP is a stock with a $140 billion market cap, and so this would reduce their shares outstanding by a little over 10%. Like AMGN, this is about equal with their annual earnings-per-share growth over the last twelve months. However, when you consider that the stock has dropped from a high price in January at around $122 to today’s closing price around $99, it make sense that the upside management could be looking at to help motivate their buyback is much larger, at around 23 based solely on the size of that 3-month drop.
Wells Fargo & Company (WFC)
WFC’s buyback is planned at about $22.6 billion, which will enable them to buy back a little less than 9% of their shares outstanding. This is actually about double their annual earnings growth, which was only a little over 4% for the last twelve months, which runs a bit contrary to the logic that most of the companies listed so far seem to be following. The counter that argument would seem to be the stock’s current price, which has dropped from a high around $66 per share to a low at around $50 in April. The stock is now around $52, and so buying back shares at the market’s current price offers about a 26% discount from that earlier high point.
Cisco Systems Inc. (CSCO)
CSCO’s planned buyback is $25 billion over the course of the year, making it the biggest of our list. That will reduce their shares outstanding by about 11.5%. That’s just a little higher than their earnings growth over the last two years. CSCO’s stock pattern is also similar to that of AAPL’s, in that after dropping back from a high at around $46 in late March, it has moved back to near those highs. The logic for the share repurchase in this case is less apparent based on the metrics we’re using in this article, but when you consider that the company is currently sitting on a cash trove of more than $73 billion, and is only carrying about one-third amount in debt, it makes sense that management would see better use in buying back shares than leaving more than $50 billion lying in cash.