I read an article here on Seeking Alpha named Buying Apple: Consider The Scale Of The Potential Investment.
In this article the author Intrepid Investor argues that Apple (NASDAQ:AAPL) (with a market cap of $700 billion) might be the inferior investment in comparison to a basket of other companies valued at $700 billion. This basket consists of Cisco (NASDAQ:CSCO), Intel (NASDAQ:INTC), Taiwan Semiconductor (NYSE:TSM), Qualcomm (NASDAQ:QCOM), SAP (NYSE:SAP), Baidu (NASDAQ:BIDU) and Hewlett-Packard (NYSE:HPQ). As you can see those are seven tech companies as well, so the comparison between the two baskets seems fair.
The author argues that Apple will likely be the inferior investment due to the fact that matters tend to stop growing once they reach a sure size and that the basket of the seven other tech companies is a better choice due to the fact that those seven have a higher complete amount of retained earnings on their balance sheet.
His first point is obviously true - a company will never be able to grow (its revenues) at a pace higher than global GDP growth forever, since otherwise it would one day be responsible for every dollar generated in the whole world. This however does not intend that Apple will not be able to grow at an above average pace for the next years, and neither does it mean that Apple's shares will not see continuing growth over time.
Despite being the biggest company in the world by market capitalization (using nominal dollar values), Apple's share of global GDP is still very little and could easily grow further: Apple's trailing revenues of $210 billion make up just a tiny portion of the global GPD of $76 trillion (that's 76,000 billion, or more than 360 times Apple's revenues). In addition to the fact that Apple could easily grow its revenues further (and there are other companies with higher revenues, e.g. Wal-Mart (NYSE:WMT)), Apple's market cap also could grow through multiple expansion (as Apple's PE multiple is under market average). And lastly, market cap expansion is not even necessary for share price gains. As Apple keeps buying back a lot of shares over time share prices (and thus the value of an investor's investment) increase, even provided the market capitalization remains flat (see this article).
Also Apple's size is not the biggest the world has ever seen when we use real dollar values instead of nominal dollar values:
Just over the last few years there were a couple of companies which sported higher market capitalizations than Apple does now. The highest one of those was Microsoft's (NASDAQ:MSFT) (inflation-adjusted) market cap of $843 billion in 1999. Apple thus has about 20 percent to go before it reaches that level. The difference here is that Microsoft has been valued at more than 70 times earnings, whereas Apple's current earnings multiple is about 15. If Apple's valuation would grow the alike way Microsoft's did 16 years ago, Apple would be valued several trillion dollars correct now.
But even Microsoft's market cap is not the highest ever, e.g. Rockefeller's Standard Oil Company was worth north of $1 trillion at its all time high (when we adjust for inflation). Saudi Aramco, Saudi Arabia's state oil company (which is not publicly traded), is even more valuable, University of Texas' Sherida Titman estimates the giant's value at $3.6 trillion (more than five times Apple's market cap).
When we go even further back in history, we reach even higher values, the biggest among them was held by the Dutch East India Company, founded 1602, which sported an inflation adjusted market capitalization of $7.4 trillion, more than ten times Apple's current size.
We thus can conclude that despite Apple's size, the company is still far from the inflation adjusted market capitalizations some companies have seen over the past centuries (and non-public Saudi Aramco is still seeing right now).
Another point is that Apple's market capitalization doesn't have to increase a lot in order for substantial gains for Apple's shareholders - the reason being Apple's buybacks (about which I wrote an article here). As an example: When Apple spends $50 billion on share repurchases, the company's market capitalization should remain relatively flat, but the share price increases about seven percent (since earnings per share grow seven percent as well). Since Apple has a enormous cash position and produces vast cash flows, Apple has a lot of money it can spend on share repurchases. Investors will thus see share price appreciation outpacing market cap growth by a huge margin.
These points mean that Apple is not too big to invest in as Apple could easily grow further, and shareholders will see attractive returns even in case the market capitalization grows only slightly.
For the second part of this article, I want to compare Apple as an investment to the basket of the seven other companies. Intrepid Investor stated that Apple was the inferior investment due to the fact that Apple's retained earnings were lower than those of the seven other tech companies. The fact that Apple's retained earnings are lower is true, but this is not a metric investors should put a lot of emphasis on. From a business point of perspective, other metrics are more important (by far).
One of the matters an investor buying a company (or a basket of companies) is looking for is the company's cash (as well as equivalents, short-term investments and long-term investments). When we compare Apple to the basket of the seven other techs, we see that Apple's total cash position is $203 billion, whereas the other seven only have a combined cash position of $161 billion (with Cisco contributing the biggest portion). A hypothetical investor spending $700 billion would thus rather buy Apple since he gets a higher cash balance for the same price (which he then can use for other investments, acquisitions, etc.).
Another metric an investor would look for is the debt that comes with the investment, as the company's debt has to be repaid one day, thus tying up the investor's cash (or cash flows).
We see that Apple has a long-term debt position of $54 billion, whereas the seven other companies have a combined long-term debt position of $88 billion. An investor willing to spend $700 billion for an acquisition thus would rather buy Apple as he would acquire more debt provided we went for the seven other companies (since buying the seven other companies would force him to pay back more debt one day, this would be a bigger drain on his cash flows).
The last point of comparison (and the most important one) is a company's ability to generate cash flows for the company's owner (or owners), as it is cash that is used to pay out dividends, make acquisitions, invest in R&D, etc.
When we look at the free cash flows generated by Apple and the seven other companies, we see that Apple's trailing free cash flow comes in at $69 billion, whereas the seven other techs have a combined trailing free cash flow of just $44 billion. An investor would thus prefer to spend $700 billion on Apple, where he gets a free cash flow yield of 10 percent on his investment, instead of spending $700 billion on the seven other techs, where he gets a free cash flow yield of just six percent.
There have been several companies which were bigger than Apple when we look at inflation-adjusted numbers. Some of them were a lot bigger than Apple is now. Apple thus has still a lot of room for growth.
Apple also seems to be the better investment than the seven tech companies Intrepid Investor suggested, since Apple has more cash, less debt and generates more cash flow than the seven others combined (for the same price).
I thus conclude that Apple is not too big to grow further (neither market cap wise, nor share price wise), Apple also is not too big to invest in. As long as Apple keeps expanding into new markets (e.g. Apple Pay, Apple Music, the coming car), Apple will be able to grow its revenues, earnings and cash flows further.
Disclosure: I am/we are long AAPL, INTC, QCOM. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose inventory is mentioned in this article.
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