Apple (NASDAQ:AAPL) stock has seen a massive swing in the last four quarters. In the quarter ending June 2018, the price increased from $166 to $187. In the next quarter, there was a further increase in price to $227. Cumulatively, these two quarters showed a price jump of 37%.
Source: Yuanbin Du Via Flickr
One of the key reasons behind this movement could be the amount dedicated to cash buybacks in these quarters. For the quarter ending June 2018, Apple spent $20.8 billion and in the next quarter, the company spent $18.7 billion. In these two quarters, close to 5% of the outstanding shares were expunged.
However, in the quarter ending December 2018, there was a correction of 32%. Apple suddenly applied the brakes on buybacks in the December ending quarter despite a massive decline in price. The buybacks in this quarter were $8.79 billion, less than half of the previous two quarters.
In the quarter ending March 2019, the price jumped from $157 to $191. Since then, Apple stock price peaked at $211 and subsequently fell to $175 on trade worries. There was little change in the expectations or core fundamentals of the company, yet we saw a significant jump and decline in Apple stock.
Investors should consider the impact of buybacks on short-term price movement to find an ideal entry point.
Difficult to Justify
In the second and third quarter of calendar year 2018, Apple bought back $41 billion of outstanding stock when the price shot up from $166 to $227. On the other hand, the buybacks were only $8.79 billion in the last quarter of the calendar year 2018, when the price cratered from $227 to less than $150. A similar trend was seen in the last quarter.
Apple bought $23 billion of stock in the last quarter, its highest quarterly buyback, which helped improve the stock momentum. The stock was at $191 by end of March 2019. Apple stock price is sometimes used as its own reason to justify the fundamentals of the company instead of the other way around. The bullish sentiment towards the stock increased massively when the stock price shot beyond $200 while it was at the lowest when Apple’s price dropped below $150.
AAPL Stock Moving Beyond Trade Worries
In the past few weeks, Apple stock dipped to less than $175. If the trade war between the U.S. and China escalates further, Apple would face significant headwinds. Goldman Sachs has forecasted that Apple could show a 29% decline in EPS if China bans Apple products. Recently, the U.S. administration has announced that tariffs on further $300 billion of imports from China could soon be announced. This would include almost all the products imported from China into the U.S., including all the Apple products.
Despite this threat, Apple stock has surged in the last few days to over $185. Again, one of the main reasons could be a higher buyback pace. Eventually, it is in the management’s hand on how fast they would like to pursue stock buybacks. But there can be huge short-term fluctuations in the stock price depending on this pace which might not be reflected by the fundamentals.
Future Buyback Story
In the latest earnings call, Apple’s management reiterated the claim that they are trying to reach a cash-neutral position. Apple has continued to show a big decline in the operating margin. In the recent quarter, Apple reported an operating margin of 23.12%. In the year-ago quarter, it was 26%. Hence, Apple has shown an operating margin decline of 288 basis points in the recent quarter. Trade worries continue to be a big challenge for the company.
From a fundamental point of view, few things have changed since the stock ducked below $145 in the last quarter of 2018. While there are a number of metrics which investors should watch to gauge the future momentum of Apple stock, the biggest factor will be the pace of buybacks.
How to Play This?
Apple had allowed the stock to decline in the holiday quarter without increasing the allotment towards buybacks. On the other hand, Apple continued to make significant buybacks in the last quarter, even when the stock price was close to $190. This shows that investors cannot be guaranteed a solid floor for the stock price.
If management plans to go easy on the buybacks in a particular quarter and the overall sentiment is also bearish, investors should buckle up for a significant decline in Apple stock. However, if the overall sentiment is bullish and the management accelerates buybacks, we can see expensive valuation levels for the stock.
The above chart shows that Apple bought back stock aggressively from April to September 2018, when the EV to FCF ratio was over 16. However, for the majority of the time in the last quarter of the calendar year 2018, the stock was below 16 times EV to FCF ratio and yet the buyback pace was very low. A big spike in buybacks in the last quarter helped in showing a bullish momentum for Apple stock.
Hence, it would be ideal to wait for a quarter when Apple is reducing the pace of its buybacks. Targeting an entry point of 10-12 times EV to FCF is also better than an entry at over 18 times EV to FCF. Investors should follow the announcements on the future direction of buybacks to get an ideal entry point for the stock.
Apple’s price movement is highly dependent on the pace of stock buybacks. The aggressive pace of buybacks helped the stock momentum in the second and third quarters of 2018, and a similar trend could be seen in the last quarter. At the same time, lower buybacks in the holiday quarter of 2018 was one of the reasons behind a 32% correction in that quarter. Apple made the highest quarterly buyback in the last quarter which helped in improving the bullish momentum for Apple stock.
Besides trade tensions, Apple stock is significantly dependent on the pace of buybacks in the near term. Investors should closely follow future buyback announcement to find an ideal entry point in Apple stock.
As of this writing, Rohit Chhatwal did not hold a position in any of the aforementioned securities.
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