What should Apple do with its cash?

Should Apple (NASDAQ:AAPL) use its massive cash balance to buy Tesla (NASDAQ:TSLA) or Netflix (NASDAQ:NFLX)?

Another quarter, another increase in Apple’s (NASDAQ:AAPL) massive cash balance.

A 27% EBIT margin over the last twelve months resulted in US$66bn in operating cash flow and US$53bn in free cash flow over this period.

Despite returning US$47bn in cash to shareholders over the past year, Apple’s net cash (cash and investments less debt) was US$158bn at 1 Apr 17 (no, that figure isn’t an April Fool’s joke). This is around 20% of its US$800bn market capitalisation.

Any way you look at it, Apple remains a cash-generating machine.

Colleague Gaurav Sodhi has correctly noted that Apple was mispriced when it traded at around US$90 a year ago. At that price, investors were paying a PER of less than 10 - and that's before taking into account its US$153bn or US$27 per share in net cash and investments at the time.

In other words, investors were then assuming minimal growth despite no evidence its fanatically loyal customers were moving to other mobile phone manufacturers nor that the high switching costs to escape the Apple ecosystem were falling.

The company sensibly took advantage of its low share price to repurchase US$34bn worth of its shares over the past twelve months. 

With Apple’s share price now around US$154, though, at around 14 times earnings net of cash Apple shares are now probably slightly undervalued or even fairly valued.

So what should the company do with its still rising cash balance?

Splurge on an acquisition?

Firstly and most importantly, it should continue to ignore misplaced calls to make a large and perhaps ‘transformational’ acquisition. Tesla (NASDAQ:TLSA) and Netflix (NASDAQ:NFLX) are the companies most often mentioned.

As well as begging the question as to why perhaps the most valuable brand on Earth needs to transform itself, Tesla is likely now an even worse investment than when I last discussed it while Netflix is, at the very least, far too expensive.

Some might argue that a large acquisition is needed to crank up growth and compensate for Apple supposedly losing its innovative edge.

In my view these concerns have little relevance. 

Buying growth for its own sake is never smart as it's unlikely to come cheaply. 

In any case, unless Apple users – of which I am one – start losing their fanaticism, even at current prices I'm not concerned that Apple is, arguably, a slow-grower.

This is because Apple doesn’t need to come up with a new innovation like the iPod, iPad or iPhone for investors to make reasonable returns from here. New iterations of the iPhone should continue to be wildly popular with users while its high-margin, annuity-like revenue from its Services business – which includes revenue from app sales, iTunes and Apple Pay – should keep growing at a rapid clip as its installed base keeps rising.  

Instead of wasting money buying Tesla or Netflix, Apple could further crank up research and development (R&D) from the US$10bn spent in 2016. Maybe another innovative product will result but, regardless, increasing R&D won’t make much of a dent in its cash balance.

Stick to current strategy

So as long as its shares remain reasonably valued, I think Apple should just stick to its current strategy of returning more cash to shareholders via dividends and – my preference – further share repurchases.

By continuing to reduce the share count, remaining shareholders should benefit even if Apple does in fact grow slowly from here.

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