Why Steve Jobs Should Have Listened to Warren Buffett
Feb 29th 2012 12:07AM
Updated Feb 29th 2012 12:26AM
It's a pretty rare privilege to be able to simply call up Warren Buffett directly and ask him for investment advice. Most people would jump at the opportunity, soak up as much of that Omaha wisdom as possible, and likely follow the Oracle's words to the letter.
Then again, most people aren't Steve Jobs.
On a recent appearance on CNBC, the legendary investor recalled an interesting phone call that he received from the Apple (NAS: AAPL) co-founder a few years ago. The hot topic of the time (that still rages on to this day) was what to do with the Mac maker's burgeoning money mountain.
The good old days
It was 2010 and Apple shares were a little over $200 at the time, and Jobs felt that shares were undervalued while Apple's cash hoard continued to burst at the seams. The size of its stash depends on when the phone call actually took place; during the four earnings releases in fiscal 2010, Apple reported cash and investments of $39.8 billion, $41.7 billion, $45.8 billion, and $51 billion, in that order.
That total has now more than doubled (or almost doubled from Q4 2010) to $97.6 billion as of the most recent blowout quarter, with Apple shares crossing the $530 threshold for the first time ever today.
Buffett outlined the four standard tools that any company can do with idle dollars: repurchase stock, pay out dividends, make acquisitions, or just plain sit on it. Clearly, Jobs picked the last choice, with Buffett recalling with a laugh: "He just liked having the cash. It was very interesting to me because I later learned that he said I agreed with him to do nothing with the cash."
Buybacks don't always work
Stock repurchases aim to deliver value to shareholders, but their ability to do so hinges on some pretty critical aspects, and buybacks can easily backfire if not done properly. If management thinks shares are undervalued, then buybacks are typically favorable, but management isn't always spot-on with valuing its company's own shares.
Of course, in hindsight, this looks like a no-brainer for Apple, considering the rally that its shares have enjoyed. But in contrast, look at Netflix's (NAS: NFLX) ill-timed repurchase program. For most of last year, it was buying back shares averaging near $222, only to sell those shares back to institutional investors for $70 -- a huge waste of shareholder value.
Netflix management certainly couldn't have predicted last year's precipitous fall, but then again its soaring valuation at its peak makes it hard to fathom that anyone thought shares were undervalued. Meanwhile, Apple's share price has just kept pace with its earnings power, so its P/E multiple never seemed that stretched.
On top of that, buybacks need to actually reduce shares outstanding to deliver value to investors, instead of merely offsetting dilutive equity compensation. Consider Activision Blizzard (NAS: ATVI) , whose buybacks over the past several years have helped meaningfully bring down shares outstanding, which is accretive to earnings.
In this case, a repurchase program would probably have benefited Apple shareholders, or at the very least helped mitigate the steady rise of outstanding shares over the past decade.
On the other hand, it's not as if you'll hear complaints coming from any investor who's held on to Apple shares for the past 10 years.
Dividends don't always work
We have a new captain now, and some type of dividend is a possibility under CEO Tim Cook. Although Jobs was never keen on a dividend, Cook has made it clear that discussions are heating up, and many analysts now think a special one-time dividend may be in the pipeline.
I don't mind that Apple has never paid me a dividend, since I know that it's always strategically used its cash to create the best supply chain in the world. On top of that, the initiation of a regular dividend signals to investors that the best growth days are in the rearview mirror, which certainly would be bad news for Apple.
The underlying theory is that a company should pay a dividend if it can't earn more reinvesting its cash into the business, or, in academic terms, if the return from reinvesting in new projects and R&D is less than the required return on equity investors demand.
In other words, it means the company has nothing else better to do with the money.
Why Apple never goes big
Regarding acquisitions, Buffett said of Jobs, "He told me they would not have the chance to make big acquisitions that would require lots of money," which goes hand in hand with why Apple never goes big with acquisitions.
Sure, Apple could buy multibillion-dollar companies, but it never will. With most of Apple's acquisitions tallying up to less than $500 million, Apple has plenty of cash to stick with its current acquisition strategy.
Steve Jobs: an enigma wrapped in a mystery with a side of secrecy
Here's part of their conversation, according to Buffett:
Buffett: I would use it for buybacks if I thought my stock was undervalued. How do you feel about that?
Jobs: I think my stock is very undervalued.
Buffett: Well, what better to do with your money?
Even Buffett is a little boggled why Jobs was so averse to repurchasing stock, considering his conviction that shares were undervalued at the time. Heck, Buffett even wishes he had picked up shares himself back then, despite his general distaste for tech companies -- other than IBM.
There are a lot of things about Jobs that we mere mortals will never understand, and we can add this to the list: calling up Buffett for investment advice and ignoring it.
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At the time this article was published Fool contributor Evan Niu owns shares of Apple, but he holds no other position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of IBM, Microsoft, Activision Blizzard, and Apple and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Microsoft, Netflix, Apple, and Activision Blizzard, creating bull call spread positions in Apple and Microsoft, and creating a synthetic long position in Activision Blizzard. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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