Apple's Share-Buyback Program Cannot Replace Top-Line Growth

Source: Apple's Statement of Cash Flows. FCF Calculation: Cash from operations-investments in plants, property, and equipment. Dollar figures listed in millions.

Interestingly enough, Apple's share repurchases have mostly been able to be supported by its free cash flow. Free cash flow is simply the cash generated from operations (the selling of iPhones, iPads, etc.) minus the cash paid for capital expenditures like plants, property, and equipment.

Although there are quarters during which the buyback exceeds the free cash flow, during the last two years, Apple's free cash flow exceeded the amount that Apple has paid for shares. And even in the event the share-repurchase program does exceed Apple's free cash flow, the company can utilize its cash pile -- which totals more than $200 billion - or borrow money at low rates from banks aware of Apple's legendary cash pile to buy back more shares.

However, there are two issues with buybacks. Most companies do them poorly, and they are no silver bullet against falling revenue and earnings.

Buying back shares serves as a put of sorts, but hasn't always been done well

Companies buy back shares for many reasons, and it's generally considered a positive sign by investors, but not all share repurchase plans are value-accretive. Perhaps the poster child of an ineffective and value-destructive share repurchase program is IBM (NYSE: IBM). In the last 15 years, the company has purchased nearly $110 billion in shares in an attempt to prop up its EPS and market cap, but has seen its market cap actually fall nearly 40% in that period as investors have grown wary of an operationally struggling company.

And it's not just IBM. Most companies have done poorly at buying back stock . Interestingly enough, companies make the same mistakes as irrational investors, buying back stock when the market tends to be overvalued, and not doing so when their shares are on sale.

Perhaps this is due to the fact that the valuations and prices of stocks are, in aggregate, positively correlated with the economic performance that provides the boost in cash and C-suite ebullience to buy back shares. A smart buyback policy should be negatively correlated with macroeconomic performance -- or to put it succinctly, "you should buy when there's blood on the streets."

Apple's share buyback is picking up, but investors still want growth

Looking at the chart, it seems that the pace of Apple's share buybacks is certainly increasing. Although the $14 billion that Apple repurchased in the fourth quarter isn't the highest total, the six-month figure of $24 billion is a large increase over the first half of the year. Whether Apple will continue this is up for debate, as Apple only has $57 billion left of its capital-return program, a designation that includes dividends.

Personally, however, I'm an Apple bull, and think that the company is undervalued, but I find it hard to accept that investors will suddenly reward Apple with higher valuation multiples after years of not doing so. To expect that to change flies in the face of Keynes' observation that, "the market can remain irrational longer than you can remain solvent." Calling for a change in sentiment is a fool's (lowercase "f") errand. In addition, slowing top-line growth generally has the opposite effect on sentiment -- it generally contracts valuation margins.

W ill Apple's top line begin to slow (or even contract)? That's an entirely different question altogether. However, I don't think its buyback policy, or a sentiment change, will save it from slowing top-line growth.

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The article Apple's Share-Buyback Program Cannot Replace Top-Line Growth originally appeared on

Jamal Carnette owns shares of Apple. The Motley Fool owns shares of and recommends Apple, LinkedIn, Tesla Motors, and Twitter. 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 .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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