How Big Is Too Big for Apple?

Apple Logo

Apple is America’s most valuable company, and the contest isn’t even close. Its market capitalization—the total value of all of its stock—is around $725 billion, about twice as much as the next largest companies such as Exxon Mobil, Google, and Microsoft. It grew so large by providing investors a return of almost 2,100% over the past 10 years, which is an average return of 36% per year. But as is often stated when it comes to investing, “past performance does not predict future results.” So will Apple stock be able to continue producing such generous returns for investors?

In theory there’s no reason why it can’t. It’s often difficult for large companies to maintain fast growth rates because their high market share mean fewer opportunities to take sales away from competitors. But the market share for Apple’s flagship product, the iPhone, is only about 20%. Such a number suggests that there’s at least a possibility of Apple continuing its dramatic growth even if other products such as the iPad, the recently released Apple Watch, or a rumored Apple electric car aren’t able to replicate the iPhone’s success.

Historically, however, companies have struggled to repeat their stock market success after they earned the title of America’s most valuable firm. Calculations by The Economist show that the four other companies that have achieved this distinction since the early 1980s (IBM, Exxon Mobil, General Electric, and Microsoft) on average had cumulative returns of 1,282% in the 10-year period before reaching the top spot, but an average return of only 125% in the subsequent 10 years.

Part of this phenomenon likely has a statistical explanation: just like athletes who have had outstanding rookie seasons may often seem to suffer “sophomore slumps” in their second years, a company that’s done so extraordinary well that it’s become the most valuable American company is unlikely to be able to maintain the same level of success. But there may be other explanations as well. It might be more difficult for a company’s executives to manage a massive organization than a smaller one, for example.

Investors shouldn’t automatically assume that Apple won’t at least partially repeat its past success. After all, Apple first became the most valuable stock in 2011, and it’s largely been able to build on its previous success since then. But if it’s able to continue outperforming the broader stock market, it would be defying the historical odds.

Apple Stock Reaches a Milestone

Apple Stock

Apple stock reached a symbolic milestone last week as the total value of all the company’s stock—its “market capitalization”—surpassed $700 billion for the first time. Some analysts are now speculating that the company could grow to become worth over $1 trillion. These numbers are gaudy, and they reflect the fact that Apple’s business has been booming. But they may distract from what Apple shareholders should really focus on, which is the stock’s total return.

“Total return” refers to the combination of the change in the price of an investment and other payments made to investors, such as dividends. This concept reflects how an investment actually affects the value of an investor’s portfolio.

A bigger market capitalization can be associated with a higher total return, but that’s not always the case. When a company pays a dividend to its shareholders, for example, the company’s market capitalization decreases (because the company now has less cash), but the total return does not (because investors have received the cash).

Since it reintroduced its quarterly dividend in 2012, Apple has been paying its shareholders more than $10 billion a year in dividends (it’s spent an even greater amount buying back its own stock, another way of returning money to shareholders). Each dividend payment lowers the total value of the company’s stock, making it slightly harder for the company to reach a new market capitalization record.

But the dividends are arguably very good for shareholders. Even after the tens of billions of dollars in dividends and buybacks, Apple still has more than $150 billion in cash and other assets that it could easily convert to cash. This large amount of cash suggests that Apple may be having trouble finding profitable ways to deploy its money, and that more dividends and buybacks may be better for Apple’s shareholders than simply watching the cash pile continue to grow. Investors cheering for Apple stock to achieve new market capitalization milestones should keep that in mind.

The Effects of Innovation

iPad

Is more innovation good for stocks? Given the success of Apple after the release of new products such as the iPhone or surging stock price of electric car manufacturer Tesla Motors, it may seem obvious that new innovations lead to better investment returns. But for the stock market overall, or even an entire sector of the market, that’s not necessarily the case.

The reason is that the gains from innovation for one company often come at the expense of other companies. Apple’s success in selling iPhones and iPads, for example, resulted in lower sales for competitors such as Blackberry, Dell, Hewlett Packard, and Nokia. And innovation can force everyone in a sector to have to spend more on research and development to keep pace, leading to lower profits for other companies even if their sales don’t decline.

Furthermore, the gains from innovation sometimes go to companies that aren’t listed on the stock market (such as smaller startups), so stock market investors don’t benefit. Until its initial public offering in 2012, for example, the increases in Facebook’s value from the growth of its social network only went to private investors such as venture capitalists. But its growth may still have hurt publicly-traded internet companies, such as Google and Yahoo!, which had to compete with Facebook.

That doesn’t mean innovation is “bad”. Innovation is almost certainly good for the people who get to use the new products, and for the economy as a whole. But just like when companies raise prices to increase their profits, what’s good for consumers may not always be good for the stock market.

The Meaning of Stock Splits

Apple Store

Last week Apple announced that it would undertake a 7-for-1 stock split in June. Such a split will result in every Apple shareholder will getting six additional shares for each one that they hold when the split takes place, and as a result the price of Apple’s shares will start trading at one seventh of their price before the split. In other words, since shareholders will have 7 times as many shares at one seventh of the price, the value of their holdings won’t change.

So why would a company like Apple want to do a split if it doesn’t affect the stock’s value? Matt Yglesias at Vox wrote a good explainer detailing the reasons.  Companies generally split their stock to reduce the price so that it’s slightly easier for people to buy and sell in round numbers of shares. Apple had the additional motivation that its split increases the chances that it will be included in the Dow Jones Industrial Average. There can also be aesthetic benefits to having a stock price that’s not perceived as “too high” or “too low”: in 2011 Citigroup pulled off a 1-for-10 reverse stock split to increase the price of the its stock after its plunge during the financial crisis.

The overall effects of these changes, however, are minuscule compared with other factors that affect stock prices, such as companies’ profitability, financial condition, and growth prospects. Stock splits change a few numbers around, but they don’t affect shareholders in any meaningful way.