The apple never falls far from the tree

The last six months have not been kind to Apple.  Their share price has fallen about 30%.  They briefly held the record for the all-time highest market capitalization of any firm.  They released their first products since Steve Jobs passed away, to mixed acclaim.  I should admit up front that I’m writing this post on an Apple computer with at least four other Apple products within 3 meters.  I’ll try to remain neutral.

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Despite the stumbles over the past six months, Apple has been an astounding success for the past decade.  If you had sunk $1,000 into Apple stock (AAPL) 10 years ago, you’d have roughly $60,000 now.  No matter how pessimistic you are or how much you dislike Apple products, that is an incredible return.  Beyond that amazing return, what makes Apple interesting?  Or at least from an accounting perspective?

Apple is sitting on a ton, a TON, of cash.  In their latest annual financial statements (September 29, 2012) they report $10.7 Billion in cash.  Scroll through the attached annual report to find the balance sheet on page 44.  That $10.7 Billion in cash is in addition to $18.4 Billion in short term investments and another $92.1 Billion in other liquid investments.  Why does Apple need approximately $120 Billion in cash and investments?  They don’t.  Most companies operate with very little cash on hand, barely scrapping enough cash together to pay the electricity bill or pay employees.  Apple is on the complete other end of the spectrum.

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A humourous article points out that Apple’s cash reserves are enough to purchase 100% ownership in Starbucks, Facebook and Yahoo.  Yes all three together.  Corporate finance theories suggest that cash management is very important for a business to succeed.  A business needs to have enough cash on hand, but not be wasteful.  Once a business gets to a stable point, they generally start repaying shareholders via dividends.  Remember that dividends are NOT an expense, they are a return of earnings and therefore reduce retained earnings.  Apple refused to pay dividends for years, arguing that it needed its massive cash resources for company purchases and to fund its large research and development costs.  Finally a year ago, Apple decided that it had more cash than it could ever use so it began paying dividends.  The third such dividend was just paid out last week, $2.65/share or about $2.5 Billion in total.  As dividends go that’s fairly large, but you need to think of the dividend as a proportion of the cost of purchasing the share.  That’s referred to as the dividend yield and for Apple is a paltry 2.4%.

Apple is currently involved in a complex lawsuit regarding the dividend payout.  It is important to note that with the current dividend rate, Apple is “only” paying dividends of $10 Billion per year and there are plenty of projections out there that suggest Apple will generate substantially more net cash from operations every year so their cash reserves could in fact be growing.  Apple is an interesting case study – they were almost bankrupt 25 years ago and some experts suggest that their cash hoarding is the result of a “depression era” mentality – they are so petrified of being near bankruptcy again that they play a very conservative game.  The other issue is that Apple is notorious for leaving significant (almost $100 Billion) cash overseas in other countries.  That overseas cash and profit was generated from legitimate sales of their products and services worldwide.  In most cases Apple has paid the domestic (i.e. local country) income taxes as required by the local jurisdiction.  Apple has taken advantage of a few low-tax countries, that’s not nefarious, its solid business planning.  The problem is that the US makes it very difficult to repatriate overseas earnings, that is, bring the money back into the US.

There are three good lessons to learn here:

  1. Cash is important which means that a company’s dividend policy is also important.  If it’s too high then the company will run out of cash.  If it’s too low, investors will be less happy.
  2. International taxation and cash management is complex.
  3. Psychology and history impacts business decisions.  We need to understand the past before we can understand current decisions.

 Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

3 Replies to “The apple never falls far from the tree”

  1. Hi again,

    As you said above, most businesses have almost no cash on hand and have cash flow problems. It’s also your opinion from an earlier blog that the cash flow statement should be the first financial statement to be presented. I’ll add that most businesses fail in the first five years of operations.

    What the textbooks don’t teach enough of is the going concern concept. Going by the pre-IFRS reliability concept and the IFRS representational faithfulness concept, shouldn’t there be an accounting standard by now that expands the definition of going concern towards full disclosure of this simple business reality of perennial cash flow problems?

    Sincerely,

    An accountant who’s glad honest unification is back on the table in our province

  2. Your third point Sandy about the importance of psychology and history brings to mind a story similar to that of Apple’s cash rich balance sheet. This one is about Ford motor company and is now 100 years old. When the Model T was selling like the newest i-product Henry Ford built up a huge cash reserve. One of the larger shareholders in Ford was a pair of brothers named Dodge, yes the same boys who went on to found Dodge Motor Cars. Henry knew they were getting ideas about starting their own company and he did not want to fund a rival by paying dividends from Ford, even though there was lots of cash to do so. When the Dodge brothers sued Ford, Henry claimed he was holding onto the money in order to build more plants, hire more workers, pay workers more so they could afford to buy Model Ts and generally do all sorts of good things with the money. The court held that there was an obligation to pay out a dividend. The case has since become the foundation of the argument that companies have a legal obligation to maximize shareholder wealth. There are a number of very well reasoned critiques of that claim, but for Milton Friedman types the ruling still prevails as good law. What is ironic about the case is that the court was reacting against Ford’s claim he was witholding dividends in effect so he could do charitable things with the money (benefit workers and communities). The claim that he was charitable seems to me to have been a legal strategy and not a genuine motivation. After all, the main objective was to keep money out of the hands of the Dodge brothers. One might also speculate about whether Henry Ford really was the charitable sort. In any case, Dodge v. Ford is a fascinating example of the importance of psychology and history not only for business decisions, but also for the laws and theories that we develop about business.

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