Apple’s cash position is collapsing, and that’s a positive for both the business and the company’s shareholders.
However, many investors and Wall Street analysts see signs of trouble as Apple’s AAPL, -0.14% cash and short-term investments have shrunk to $48 billion at the end of June 2022 from $107 billion at the end of 2019, a decrease of 55%.
According to a long-standing theory in corporate finance, cash-strapped companies underperform those with smaller savings accounts, on average. This theory was presented several decades ago by Michael Jensen, professor emeritus of business administration at Harvard Business School. In a now famous 1986 article in the American Economic ReviewJensen argued that companies would be less efficient to the extent that they accumulated cash beyond what was needed for current operations.
Why would too much money be a bad thing? Jensen theorized that it encourages company managers to engage in absurd behavior. Jensen argued that shareholders should try to “motivate managers to pour in cash instead of investing it below the cost of capital or wasting it on organizational inefficiencies.”
This is the theory. But does it hold up in practice? To find out, I reached out to Rob Arnott, founder of Research Affiliates. Arnott co-authored a 2003 study (with Cliff Asness of AQR Capital Management) that provided empirical support for Jensen’s theory. Their study, which appeared in the Financial Analysts Journal, was titled “Surprise! Higher dividends = Higher earnings growth.”
They looked at corporate earnings growth over 10-year periods between 1871 and 2001 and found that earnings grew faster after the years when companies’ dividend payout ratios were the highest. Companies that hoarded their cash instead of distributing it to shareholders performed worse, on average.
In an interview, Arnott said he believes the conclusions he and Asness reached two decades ago still hold. So he sees Apple’s cash crunch as positive for the company’s future prospects.
What if Apple in the future needs the cash it no longer has? Arnott replied that the company would only need to approach the debt or equity markets to raise the cash, which it would have no problem doing, as long as it uses the cash for a productive purpose. This condition is the key to why a small cash reserve is positive, Arnott argued: It imposes market discipline and accountability on any new project or investment a company wants to make. In contrast, with high levels of cash, there is no such discipline or accountability.
In any case, Apple does not seem to suffer as a result of the decrease in its cash pool. Since the end of 2019, during which its cash and short-term investments have fallen 55%, the return on equity has risen to 163% from 55%, according to FactSet. Over the same period, the stock has produced an annualized total return of 35.3%, tripling the 11.1% of the S&P 500 SPX, -0.16%.
The bottom line? As plausible as the narrative is that reduced cash levels are a bad omen, it actually appears to be a positive development. The broader implication of investment is to dig below the surface when these narratives are presented.
Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
Hear from Ray Dalio at Best New Ideas in Money Festival on September 21 and 22 in New York. The hedge fund pioneer has strong opinions about where the economy is headed.
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