Apple Stock Buybacks and VTSAX

[schneider]

I lurk here enough that I think this hasn't been posted but apologies if something relevant has.

I have never bought an individual stock, and I'm an anxious enough person that I try not to read the financial news, so I failed to notice that Apple has bought hundreds of billions of dollars of its own shares for the past half-decade or so and plans to keep doing so indefinitely.

Here's the stupid question: this should, in the long run, and independent of everything else, lower Apple's share of VTSAX (or, you know, the actual total market it tracks) and increase its P/E… right?

The model I have in my head is that Apple makes a certain amount of money per unit time: they distribute some of those to public shareholders in the form of dividends, they distribute some of that to their employees in the form of salary and stock compensation, and, lately, they sit on some of it, which should raise their stock price by value of the money they're sitting on divided by the number of stocks. (Of course, since the actual stock price is set by the market, it's not obvious that we would be able to separate that from all the other fluctuations.) As they buy back shares from the public, the individuals people who sell get a one-time cash out, Vanguard sells to follow the market (meaning that we get some cash too), and more of all future profit gets to go to their employees and less gets to go to us. You could even imagine Apple becoming a privately-held company if this went on long enough, in which case our share of the profits, if all we held was VTSAX, would be zero.

That feels wrong, because the implication is that passive investing could have a big problem in a few decades. On the other hand, private equity owns more and more of the market every year. And, while it's been a few years since I pretended to read Piketty's book, I seem to recall that might have been the point there too.

Of course, none of this matters at all if Apple ceases to sell things at a price higher than what it cost them to make them, but, all other things being equal, does that sound at all correct?

[sokoloff]

Apple buying back shares doesn’t lower its market cap much. The distribution, whether in the form of dividends or buybacks, modestly reduces the company value (as a transfer to shareholders, including VTSAX). Most of Apple’s value is outside its cash balance.

It will not increase the P/E, as the P/E is the market cap divided by total earnings. The market cap may go modestly down (cash out of company); the earnings will be essentially unchanged. (Reduced by the trivial amount of interest on cash balance now not held.)

[Telecaster]

The model I have in my head is that Apple makes a certain amount of money per unit time: they distribute some of those to public shareholders in the form of dividends, they distribute some of that to their employees in the form of salary and stock compensation, and, lately, they sit on some of it, which should raise their stock price by value of the money they're sitting on divided by the number of stocks. (Of course, since the actual stock price is set by the market, it's not obvious that we would be able to separate that from all the other fluctuations.) As they buy back shares from the public, the individuals people who sell get a one-time cash out, Vanguard sells to follow the market (meaning that we get some cash too), and more of all future profit gets to go to their employees and less gets to go to us. You could even imagine Apple becoming a privately-held company if this went on long enough, in which case our share of the profits, if all we held was VTSAX, would be zero.

If I understand your question correctly, the answer is no, because the shares are retired when they are re-purchased.  So  AAPL's market cap remains the same after a buyback, however each individual share is worth more money.  That increase in share price, in theory, benefits VTSAX holders because AAPL is one of the largest components. 

[fattest_foot]

If I understand your question correctly, the answer is no, because the shares are retired when they are re-purchased.  So  AAPL's market cap remains the same after a buyback, however each individual share is worth more money.  That increase in share price, in theory, benefits VTSAX holders because AAPL is one of the largest components.

Thanks, I was actually wondering how this would impact index funds yesterday.

A lot of the talk prior to the tax changes going into effect was that companies would use a large portion of their repatriation and savings doing buybacks. I couldn't figure out how that would work for shares held in an index fund, however. This clears it up a bit.

[starguru]

Market cap is share price times pricer per share.  If a company buys its shares back (and retires those shares), all other things being equal, the market cap stays the same, thus the share price increases.

Of course, in real life, not all other things are always equal, so if a company buys some of its shares back at the same time the fear mongers on bloomberg or the talking heads on the TV start mentioning how something "might" be going wrong in the world, the price per share, and thus the market cap, might go down.  In theory you can argue that the company buying its shares back might soften the decline for that company, but at this point it doesn't really matter.  The real world is too complex to know all the relationships that are causing prices to change.

So market cap isn't really affected by share buy backs.

...they sit on some of it, which should raise their stock price by value of the money they're sitting on divided by the number of stocks...

yes and no.  There is often times little sense in how a market values a company.  In theory, market cap would be based on present value of the company's assets plus expectations about its future earnings.  So having more cash on hand in theory could be reflected in share price for the company, as the share price is in part a reflection of value.  In the real world it doesn't work that way.  People interpret things, basically making things up.  Having a lot of cash on hand might lead "analysts" to think that the company has no ideas, no ways to spend the money, no innovation left in, leading to panic selling.  You use Apple as an example, in 2013 at one point the market cap was at ~$350billion, while it held something like $150billion in cash.  So at that point the market valued the company at only less than 3x the cash it had on hand, not counting the BILLIONS it was doing in business every quarter.  The P/E was 8 or something stupid like that.  The real world is too complicated for these simplistic examples. 

Passive investing wouldn't be bothered by share buybacks in general.  It's just orthogonal to the principle.

[schneider]

Thanks for the replies, everyone. That clears things up a lot.

So, if I've got it straight… a buyback is, to someone who holds index funds in an account where there aren't tax concerns, exactly the same as a dividend for all practical purposes. Right?

It's kind of curious that a company that's undergone several stock splits would do this instead of just increasing dividends; I assume the answer comes down to:

The real world is too complex to know all the relationships that are causing prices to change.

I sure do wish there were a more rational place to put my money! ;)

[starguru]

Thanks for the replies, everyone. That clears things up a lot.

So, if I've got it straight… a buyback is, to someone who holds index funds in an account where there aren't tax concerns, exactly the same as a dividend for all practical purposes. Right?

It's kind of curious that a company that's undergone several stock splits would do this instead of just increasing dividends; I assume the answer comes down to:

The real world is too complex to know all the relationships that are causing prices to change.

I sure do wish there were a more rational place to put my money! ;)

Stock splits have nothing to do with buy backs.   It doesn’t matter if the company buys 1 share for $1000 or 10 shares for $100each, it still bought $1000 worth of shares back.


Sent from my iPhone using Tapatalk

[sokoloff]

It's kind of curious that a company that's undergone several stock splits would do this instead of just increasing dividends

Buybacks are preferred to dividends for two reasons IMO:
1. They are more tax-efficient than dividends.
2. There is a larger perceived (and largely real) penalty to cutting a dividend; there is a smaller penalty to pausing or scaling back buybacks.

[Bill_]

It's kind of curious that a company that's undergone several stock splits would do this instead of just increasing dividends

Buybacks are preferred to dividends for two reasons IMO:
1. They are more tax-efficient than dividends.
2. There is a larger perceived (and largely real) penalty to cutting a dividend; there is a smaller penalty to pausing or scaling back buybacks.

Buybacks can suck for one reason:

1) Most companies only buy back their shares at the market top (nobody was buying back shares at the market bottom in early 2009), when times are good and they have lots of cash. Berkshire refuses to do this, they only buyback shares when market value fall below a certain benchmark.

[CCCA]

Apple did, by the way, raise their dividends as well (to $2.92/share).  At current prices of $185/share it's about 1.6% dividend yield.  Not super high.  Given that their earnings per share (EPS) is almost $10/share, there's room to increase that dividend yield, especially since they'll be retiring shares (maybe ~10% of them) and thus their EPS will increase by 10-15%, all else equal.