Apple Inc (AAPL)

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Apple’s enviable cash supply is dwindling. Here’s what that means for the stock
By: Mark Hulbert | August 5, 2022

Apple’s cash position is plummeting, which is positive for both the company and the company’s shareholders.

Still, many Wall Street investors and analysts are seeing signs of trouble that Apple’s 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 55% drop.

According to a long-standing theory in corporate finance, companies with cash inventories perform worse on average than those with smaller savings accounts. This theory was expounded 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 Review, Jensen argued that companies would be less efficient to the extent that they hoarded more money than was needed for current operations.



Why would too much money be a bad thing? Jensen theorized that it encourages business managers to engage in foolish behavior. Jensen argued that shareholders should try to “motivate managers to spend the money rather than invest it below the cost of capital or waste it on organizational inefficiencies.”

That’s the theory. But does it hold up in practice? To gain insight, I reached out to Rob Arnott, founder of Research Affiliates. Arnott co-authored (with Cliff Asness of AQR Capital Management) in 2003 a study 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 analyzed corporate earnings growth over 10-year periods between 1871 and 2001 and found that earnings grew fastest after years when companies’ dividend payout ratios were highest. Companies that hoard their money 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 are still valid. He therefore sees Apple’s dwindling cash supply as positive for the company’s future prospects.

What if in the future Apple needs the money it doesn’t have anymore? Arnott replied that the company should only approach the debt or equity markets to raise the money, which it would do without a hitch — provided it used the money for a productive purpose. This caveat is key to why a small supply of money is a positive, Arnott argued: It imposes market discipline and accountability for any new projects or investments a company might want to make. With high levels of cash, on the other hand, there is no such discipline or responsibility.

In any case, Apple doesn’t seem to be suffering from the reduced cash supply. Since the end of 2019, when cash and short-term investments fell by 55%, return on equity has increased from 55% to 163%, according to FactSet. Over the same period, the stock has posted a total return of 35.3% yoy, tripling the 11.1% for the S&P 500 SPX,
-0.08%.

It comes down to? As plausible as the story may be that shrinking cash levels are a bad omen, they actually appear to be a positive development. The broader implication of investment is to dig under the surface when such stories are presented.

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