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Apple's Moves Make The Stock Look Better, But Is It Worth More?

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This article is more than 9 years old.

Apple just announced that it plans to split its stock, 7-for-1. Is that impressive or what? But wait, that’s not all! It also plans to repurchase $90 billion of its stock. Impressed even more? But that’s still not all! It also plans to boost its dividend payout ratio to 8%.

Some investors will be impressed; but other investors will wonder whether they are being pitched, along the lines of a television commercial, to buy Apple stock.

For what it’s worth, here are a few reflections from my behavioral finance corner of the world, which coincidentally sits a stone’s throw from Apple headquarters in Cupertino, CA.

Reflection #1: The academic evidence suggests that companies which split their stock subsequently experience positive drift in the prices of their shares. On average, firms splitting their stocks earn an average abnormal return of 7.4% during the first year, and just over 12% for the first three years. Moreover, we know that management’s decision to split the stock of their companies depends on more than the current stock price. It also depends on whether analysts following the stock are pessimistic about the company’s future prospects.

Managers are more apt to announce stock splits when they perceive analyst coverage to be negative. As for Apple, the analysts who follow the company have given it a consensus recommendation of 2.1 out of 5, where 1 is tops, and 4 is about as low as analysts are comfortable going. Just to put things in perspective, a rating of 2.1 is almost as good as Ebay ’s 2.0, and better than Wal-Mart’s 2.5.  A wider span includes Google ’s recommendation rating of 1.4, Facebook’s 1.8, and BlackBerry’s 3.4.

The academic evidence suggests that companies that decide to split their stock are, on average, less likely to experience future earnings declines, relative to peers.

Takeaway: If Apple management’s interest is in increasing its stock price, then splitting its stock won’t hurt. Analysts might be concerned about the company’s pipeline of new products, but relatively speaking they are not down on the stock.

Reflection #2: The academic evidence suggests that after companies announce plans to repurchase their shares, their stock prices go up, not just immediately but thereafter with positive drift. The average market response to the announcement of an open market purchase is 3.5%. The average abnormal long-term performance after the initial announcement is 12%.

I know professional money managers who trade on repurchase announcements, and successfully at that. They know that the effect of a repurchase is strongest when the announcement is accompanied by managers explicitly indicating that they believe the shares of their companies to be undervalued.

Apple has had a repurchasing plan in place for several years. Apple’s stock has declined by about 25% since it peaked in September 2012. Neither the recent past, nor the company’s announcement this week suggests that managers actually believe that Apple’s stock is undervalued.

Takeaway:  If Apple management’s interest is in increasing its stock price, then buying back shares won’t hurt. However, the same remark applies here as above: relatively speaking analysts are not down on the stock. Still, if the stock split induces positive drift, then repurchasing will be a good deal for firm’s shareholders who continue to hold the stock.

Reflection #3: The academic evidence tells us that some investors like cash dividends, and that some companies cater to investors’ taste for dividends. The evidence tells us three important things about dividend increases. First, companies tend to increase dividends after past earnings have improved. This certainly applies to Apple. Its current EPS of $11.62/share handsomely beat analysts’ consensus estimate of $10.14/share. Second, stock prices usually respond positively to announcements about dividend increases. Following its announcement, in after-hours trading, Apple’s shares increased by more than 8%. Third, firms that increase their dividends tend to be less likely to experience decreases in future earnings than firms that maintain payouts. On this one, the jury is of course still out.

Dividend policy is complicated. Money that Apple pays to shareholders is money that it could use to fund promising new projects. Therefore, increasing the dividend payout ratio could actually be a signal of bad news to come. However, Apple is also planning to increase its borrowing. Therefore, funds will remain available to back good projects, if Apple has them.

And there is one other point to note: if Apple's shareholders were inclined to waste money backing poor projects, and had the cash to do it, then all shareholders could do would be to sit by and complain. However, if by increasing its dividend payout, Apple forces itself to go to the capital markets to raise money. As a result, investors have opportunities to ask questions before handing over their money to Apple. This means that the combination of higher dividend payouts and additional borrowing enables the capital markets to inject some additional discipline on Apple's managers.

Takeaway:  If Apple management’s interest is in increasing its stock price, then increasing its dividend payout won’t hurt.

Reflection #4: Stock repurchases + higher dividend payouts + increased debt = more leverage for Apple. Higher leverage generates tax shields, which will be good news for Apple shareholders, who will see its corporate tax bill drop relative to what it otherwise would have been. In addition, higher leverage will produce higher EPS and ROE than otherwise if Apple’s future is favorable, but lower EPS and ROE than otherwise if Apple’s future in unfavorable.

Takeaway:  Whether Apple’s future is favorable or unfavorable depends on its product strategy more than its financial strategy.

There is no crystal ball in my behavioral finance corner of the world, and so I make no predictions about Apple’s future stock returns. The best I can do is to suggest that viewed against the backdrop of the academic evidence, the return to Apple’s stock looks more favorable, but also more risky, after its series of announcements than before.