In a hypothetical buyback program let’s say that Apple Inc. (NASDAQ:AAPL) spends $1 billion per week on share buybacks over the next two years. This would result in a total of $104 billion in buybacks, easily covered by the current cash balance. As long as the price which the company pays is below the fair value then there is a net benefit for shareholders. Below is a table of the number of shares which would be bought back over this two-year period for various average share buyback prices. The current diluted share count is 947 million.
| Avg. buyback price | Number of shares repurchased |
|---|---|
| $430 | 241.86 million |
| $460 | 226.09 million |
| $500 | 208 million |
| $550 | 189.09 million |
| $600 | 173.33 million |
| $650 | 160 million |
If Apple Inc. (NASDAQ:AAPL) were able to repurchase all $104 billion of shares at the current market price the share count would be reduced by 241.86 million, or 25.5%. Of course, the introduction of this program would most likely cause shares to rebound to some degree, so I’ll assume that $550 is the average buyback price. This is close to the average between the all-time high of $700 per share and the current price of $430 per share. In this case the share count would be reduced by about 20% by the buyback program.
To value Apple Inc. (NASDAQ:AAPL) post-buyback I’ll use the same methodology from my previous article – a simple discounted cash flow calculation. My slow-growth scenario assumed 6% annual growth for 10 years and 3% growth after that, so I’ll use the same assumptions here. Now, over two years the $104 billion spent on buybacks would partially be replenished by the free cash flow. Some of this will go to dividends, so I’ll be conservative and say that $60 billion is added to the balance sheet in cash over the next two years. This would put the total cash level at $93 billion at the end of the two year period. With the newly reduced share count this is about $122 per share, slightly less than the $144 per share of cash today.
The real value is added from profits being split over fewer shares. Since the share count is reduced by 20% the FCF per share is increased by that same amount. Doing the same calculation as in the previous article the new fair value of a share of Apple Inc. (NASDAQ:AAPL) after this two-year buyback program is $755 per share. This is a 16% increase in the fair value and a full 75% higher than the current share price.
The bottom line
While share buybacks are often claimed to be a good idea it’s rare that the effect on the fair value is even talked about. In the case of Apple a share buyback program can greatly increase the fair value of the stock as long as the company doesn’t overpay. Obviously the numbers change if you believe that Apple Inc. (NASDAQ:AAPL) is worth more or less currently than I’ve assumed here, and this calculation is rough to begin with. But I think it’s clear that a buyback is the best option for Apple. Dividends are all well and good, but they don’t add to shareholder value like buying back undervalued shares. A massive Apple buyback is the best use of Apple’s cash.
The article A Massive Apple Buyback originally appeared on Fool.com and is written by Timothy Green.
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