What happens when a company liquidates? The assets are divided among the stakeholders, until there is nothing left. When a company is claimed to be a going concern, rather than in liquidation, and it pays out more than it takes in, it is a Ponzi.
Apple’s deficit isn’t 10-30B over ten or fifteen years. It has bled away $80B of equity in only five years. If this trend continues, they will eventually end up like Boeing, with tens of billions of negative equity, nothing but a mountain of debt. What happens if the bankers decline to let the company continue accruing debt to infinity?
Or, using your debt proposition, what if something happens, like the Fed stops suppressing rates, and raises interest rates instead? Being leveraged out of their skills is no longer so advantageous. Will the company start selling stock? What will happen to the per share price due to that dilution?
They are playing a dangerous game, but, in Welchian fashion, they are gambling it will be the next CEO’s problem.
Financial markets are known for periods of being highly irrational. During the Dot Con bubble, stocks WITH earnings underperformed stocks WITHOUT earnings.
The bankers would probably call a halt to lending, before the company got to that point. Currently Boeing has $136B in assets, and only $47B in long term debt, but Boeing’s total liabilities are nearly $152B, courtesy of negative equity of over $15B. If Apple continues to spend more than it takes in, it will, in a few years, be in the condition Boeing is in.
It worth bearing in mind that Steve’s concern is not advice that will necessarily make you money. His examples are BA, WMT and AAPL. One seriously underperformed, one seriously overperformed and one was middling. Taken as a portfolio they did better than SPY.
One needs to look at factors other than stock buybacks (and I don’t think any of the three companies are going out of business).
The problem is in the future. If shareholders’ equity is going down and assets are constant or rising, liabilities must be increasing.
Let’s go back to the most basic accounting equation: Assets = Liabilities + Equity
This equation always holds true.
So if Equity is falling - as it has been at Apple - either Assets must also fall or Liabilities must be rising faster than Assets. Or perhaps a bit of both.
Retained earnings is a subset of equity. So companies are funded via equity or debt. In practice, its a combination of both. The equity can come from the sale of shares, or it can come via retaining earnings. Either way, it’s equity. I’m going to ignore share count for the moment, as it’s mostly irrelevant.
That’s a misunderstanding of what Steve is saying. He saying that Equity - the combination of the proceeds from issuing shares and retaining earnings - has been decreasing.
Balancing debt financing against equity financing is a complex issue. There is no one right or wrong way to do it. (Well, there is one wrong way - letting equity go negative. That means the company is technically bankrupt. It owes various people more than it has. As long as those lending money to the business are OK with that situation, the business can carry on. But it had darn well start making a positive profit so that the debts can be serviced.)
And that is the issue Steve is pointing out. Both Walmart and Apple are on a trajectory that is reducing their equity financing and increasing their debt financing. In the olden days of the 1990s, that was called leveraging the business. Borrow money, pay that out to the shareholders (therefore reducing equity), and you get a temporary increase in the return to shareholders. But that can’t go on forever. Leverage too far, and the business becomes fragile. It can fail from a small increase in the cost of borrowing. And a large increase - like has happened over the last 2 years - can be disastrous.
So this combination of increasing leverage at a time when interest rates are rising should be a cause for revisiting the investment thesis in these companies. Perhaps things are fine and they are just getting their debt/equity lined up for the next few years. Perhaps things are not fine and they are getting over-leveraged. That would take some more detailed investigation, which is something I haven’t done.
Consider the time scale. BA’s equity peaked out in 2013, at just under a positive $15B. BA has since stopped it’s divi, and stock buybacks, so equity has improved from -$18B in 2020, to only a negative $15.8B in 22, but management has managed to smoke $30B of the shareholder’s equity in 9 years.
WMT’s equity has wobbled between $80B and $90B for a number of years, in spite of booking $10-$15 Billion in profits/year, where BA has been losing Billions. If they were investing those Billions every year in the business, it would show up in the retained earnings part of equity, but it goes up in smoke instead. The highest point was almost $92B in 22, but, equity fell to just under $84B for 23. As we saw in their Q1 report the other day, they have now smoked another $4B of equity, in only three months.
Apple’s equity peaked out at $134B in 17, then dropped every year, landing at a bit over $50B for 22.
So, looking at the trend, and time, BA has been liquidating the longest, and is in the deepest kimchee, Apple will be next to fall into negative equity, and WMT the last.
It was called the same thing when I was in b-school in the 70s, in a rising rate environment, that was putting highly leveraged companies, like Chrysler, in a bind.
Which assets specifically do you think Apple has liquidated? Other than purposely taking on opportunistic debt, all their distributions come from real cash earnings. If they hadn’t bought back shares and issued dividends, they’d have something like $600B cash in the bank. And they were already roundly criticized for having “too much cash” when they only had $200B of it!
Like I said earlier, I don’t fully understand the accounting aspect of “shareholder equity” on the balance sheet. But now I can see that you don’t fully understand it either.
Put it this way, would you rather own a company that has $40B in shareholder equity one year, and $41B the next year, and earned $10B, or a company that has $40B in shareholder equity one year, $39B the next year, and earned $15B or which it used $5B to buy back shares and issue dividends?
Well, from the numbers I am looking at, not really. According to the balance sheet numbers on Yahoo, from 2019 to 2022:
Cash declined from 100,557,000 to 48,304,000
Equity declined from 90,488,000 to 50,672,000
Net debt increased from 59,203,000 to 96,423,000
Buybacks and divis juice the price of the stock. EPS and return on equity are both juiced by having fewer shares and less equity. But if the trends evident at Apple continue, at some point, the buybacks and divis will need to be eliminated, as they were at Boeing. What happens to the stock when the support from buybacks and divis ends?
Funny, my cash also declined from 2019 to now. That’s because I shifted much of it into things that earn more interest than cash. Like CDs and treasury bills. You should probably look closer at. that balance sheet and you might discover that they did something similar.
Which indicates the business (or the cash-on-hand, anyway) was improperly managed and nobody caught it (until NOW?). The options for business are far greather than for individuals.
This is not as straightforward as reading the financial statements. This enters into their businesses models and the competition. This enters into where the owners are investing elsewhere. What Steve is saying does not surprise me.
The dynamic on the income statement can be a mixed message. In the markets for goods and services there might be no avoiding this.
I’m not the balance sheet expert here, you are! All I know is that the CFO on the last 5 or 10 earnings calls has said that they are purposely trending to be nearly cash neutral. I understand that to mean that cash (presumably actual cash and instruments that can be readily sold for cash) is roughly equal to debt. This, in fact, was in response to complains from the financial press that they were holding “too much cash” and not using it for productive purposes. So they decided to give most of it back to the shareholders in the form of dividends and buybacks.
So if he (the CFO) is telling the truth, their “cash” should roughly equal their debt. Plus the fact that they bring in tens of billions in cash each year, replenishes that amount on a constant basis … at least for the last few years while business has been good.
Besides, if they are “liquidating” as you stated, why does the market value keep rising???
That is the whole point but I am shy about saying it. When there is no point to investing in a business we slowly walk away. It can be shocking who walks away but it can be rewarding figuring out the successors.
The problem is not investing is more dynamic than share buybacks or dividends.
In 2019 rates were near zero so it dodn’t make much of a difference if you held cash or a one year bill. Now it makes a big diofference, you can get 4 or 5 percent.