Excellent comments on a whole, but I have to question this one. A separate line on the balance sheet yes, but investment income is counted in earnings in the end and reported as such.
First let me correct myself.... it's a separate item on the cash flow statement, not the balance sheet. Now let me clarify: My point here is that from an operations stand point, it is not operating income, and it's not part of operating cash flows, and it's not income generated by changes in working capital (inventory). So, from my point of view I'm excluding it because it doesn't tick and tie with what I'm evaluating, which is the company's ability to generate continued business.
Earnings is a number that can be manipulated by many non-operating activities, and cleverly timed changes in investing and financing activities... I look strictly at operating cash flows as a measure of the business, because Apple, Pepsi and Company XYZ could all identical returns if invested in the same financial instruments. But even if Apple and its competitors had the same inventory amounts, what separates them is what they do that is uniquely Apple, or uniquely Dell, or uniquely Pepsi... which reflects the output of the two less tangible categories of my typical analysis: competitive moat and soundness of management.
Not that Apple should stockpile cash and investments as a way of building earnings.
Of course not. They don't do this exceptionally well as evidenced by their overall return. By "exceptionally" I mean that it's a nice ancillary return but they're not particularly better at it than companies who specialize in private equity or fund management. They're much better at turning computing devices into cash.
Ideally free cash goes towards expanding a company's core business. We don't want to see our favorite tech company turn into a bank or a huge portfolio manager if only because they cannot be expected to generate a ROI on those types of investments rivaling those they could obtain through the business where they have real expertise.
Failing the ability to spend their free cash on expanding their business (and at this point I think it is abundantly clear that Apple cannot) then some of that excess should be paid out to the stockholders. It's high time.
That's a different debate... but I don't agree with it because I've pointed out that having that cushion gives them a tremendous advantage in numerous areas, including but not limited to:
Insurance against operating income fluctuations due to economic conditions, coverage against litigation settlements/patent disputes, ability to demand special pricing agreements on both supply chain as well as investment instruments, insulation against loss of principal (every dollar lost is a dollar plus interest in future value sacrificed, depletion of principal would slow their growth during certain periods), insulation against future changes in cost of capital, etc. Consider that for the $67 billion in long term securities they have, they are generating a steady stream of investment income. It's THAT stream I'd draw from for organic growth, rather than go for depletion of principal. As principal grows, so does their cushion AND their total investment income.
What bothers me about the arguments that Apple should spend it as if it's burning a hole in their pocket is it reminds me of the tendency to think "Hey wow, I got a big bonus, I should run out and get a big TV." Why? What's that TV going to do to increase the stability of your household that the same amount of money can do just sitting there earning a return?
Apple has to also look at how much of that remaining pool they can possibly acquire and manage within a given timeframe. Companies that try to grow too fast suffer from two problems: Their quality of products and service declines if they can't scale operations at the same rate they scale sales. Sales is just a numbers game (throw crap to the wall and see what sticks) but customer retention is not. Think about the hiring, training, facilities management, etc. that all goes into handling what to do with a customer once you have them. They're depleting the available pool. If they grab a ton of customers this month, they've removed those customers from next month's pool... I'm not going to buy a laptop twice in two months. They're not hurting for operating income, so it's pretty wise to pace their growth while other companies crush themselves trying to be the Wal-Mart of computing.
If Apple were very poor at generating operating cash flow (and consistently so), then I would prefer dividend distribution because I would have a better idea what to do with that money than they would. But if they're smart within their core competency, just as Buffett and Munger are with Berkshire, I would rather they keep that money as added float to insulate them against various types of risk and accelerate their growth relative to their peers whose leveraged growth will always hobble their operational returns and expose them to risk unnecessarily.
But ultimately, again, what I'm not doing is trying to replicate the equivalent of what they report under GAAP requirements. I'm trying to arrive at a price I think is a sensible purchase limit, and then get in with a margin of safety (i.e. some price beneath what my estimate of their operating value is).
Compared to using market price, P/E multiples and other metrics that are all skewed to inflate performance and value, I think it's the sensible approach to evaluating a business... It doesn't matter what I think they'll eventually go to. That's highly speculative unless you're inside the company and know all the inputs to sales forecasts (which is basically what I do for my employer).
I basically find a price I think reflects the true operating value, buy at some price beneath that, and wait until the market is dumb enough to overprice it. That's basically all that Buffett, Munger, Eviellard, Schloss, Perlmeter and others have done, and kept doing again and again, that made them billionaires over time. I cannot name a single speculator/day trader who became a billionaire and (most importantly) stayed one.
If you keep buying a dollar worth of assets for sixty cents, you'll do very well in life.
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