I wrote a column last week with the title, "Beware of Stock Buybacks" in this current market environment. The basic premise was that many companies used share repurchases incorrectly. They were using them not as a tool of creating true shareholder value, but to appease analysts and those investors who don't understand that buybacks can be deadly if done for the wrong reasons.
Investors ought to be skeptical of buybacks done when markets are at elevated levels as they are now. Often blinded by overconfidence and idle cash, executives start buying back shares at the wrong time when prices are high. I gave in that column examples of good and bad share repurchases. It all comes down to price paid for the value received.
I also referenced why activist investor Carl Icahn was chomping at the bit to get Apple (AAPL) to buy back shares. On Thursday, in a nice dose of refreshing news, Apple announced that it had purchased $14 billion of its shares in the past two weeks. Perhaps Icahn's vocal stance played a part, but the Apple buyback is a great example of a stock buyback done right.
First, the company reported "disappointing" results two weeks ago that sent shares down over 8% in a day. CEO Tim Cook noted that the drop in price is what spurred the buyback. For months, Apple had made little or no purchases of its own stock, despite the pressure. But when the market panicked and sent shares lower, the company moved boldly, precisely how you should behave in buying back stock.
The action brings Apple's purchases to $40 billion over the past 12 months. At current valuations, the company has retired nearly 10% of it shares in the past year.
It will be interestingly, however, to see whether this particular buyback has placed a floor on the share price. Of the $14 billion, $2 billion was open market purchases -- meaning the purchase price was likely around $500 a share, which was Apple's low in the past two weeks. The other $12 billion may have been done at a modest discount. By that metric, if the shares were to drop below $500, that may be a very good time for Apple fans to buy as it could mean more buybacks are coming.
At Apple's upcoming annual meeting later this month, shareholders will vote on an Icahn-sponsored proposal to add another $60 billion to the buyback kitty. My guess is that the proposal will pass. If it doesn't, Apple has clearly signaled its own willingness to buy back its own stock.
Apple's lesson is a simple, but important one: it is a company flush with cash that so far has been patient in allocating that cash. Apple's not going out and making any acquisition or buying shares at any price. It's holding on to that cash and betting big when opportunities arise. That's how good capital allocation works and Apple shareholders should be pleased with the move.