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I’m looking through the volume leaders this morning to find a theme for today’s commentary. Barchart.com’s data tells me that Apple (AAPL) has the 12th-highest daily volume, with a little more than 26 million.
Now, there's nothing special about this amount. The iPhone maker’s average 30-day volume is 57.6 million, more than double the action so far on Wednesday. However, I’m not sure why this happens. Whenever I look at the volume leaders' stats, it opens on the debt page. I must have done a particular screen at one point involving debt, but I digress.
In addition to the debt/equity ratio, the data includes interest coverage and profit percentage. I click on the profit percentage stat to get a ranking from highest to lowest. Apple is in 20th spot at 25.31%.
The debt/equity ratio to the left of it says 1.63, which means that its total liabilities are higher than its equity. That can often mean that a company is overly leveraged and could become a problem in the future.
However, in Apple’s case, that’s not what’s going on here, but I thought I’d highlight how investors using stock screens and technology can get the wrong end of the stick.
Why Does Apple Have More Debt Than Equity?
If you look at Apple’s 2023 10-K, you will see that its shareholder’s equity at the end of September was $62.15 billion, up from $50.67 billion in 2022. Its total debt in 2023 was $123.93 billion, down from $132.48 billion in 2022.
As I said previously, its debt/equity ratio, according to the Barchart data, is 1.63. If I divide its debt ($123.93 billion) by its equity ($62.15 billion), I get 1.69. Close enough.
So, Apple wouldn't make it onto your screen if you were to do a stock screen looking for financially healthy businesses and set the upper limit of the debt/equity ratio at 1.0. I’m pretty sure it’s not the type of company you want to exclude from consideration.
To understand what’s happening here, you need to look closely at Apple’s capital structure. Go to its Consolidated Statements of Shareholders’ Equity on pg. 31 of its 10-K.
Apple made nearly $97 billion in 2023, yet it didn’t increase its retained earnings -- defined as the income earned that’s not paid out as dividends but kept for later use -- in fact, it had an accumulated deficit of $214 million.
How is that possible? Share repurchases and dividends are subtracted from net income.
Its common stock and additional paid-in capital was $73.81 billion at the end of September.
Apple’s accumulated deficit at the end of 2022 was $3.07 billion. Add the $214 million from 2023, with an accumulated deficit of $3.28 billion. The accumulated other comprehensive losses balance in 2023 was $11.45 billion. Most of these losses were from the change in fair value of marketable debt securities in 2022. Subtract these two from $73.81 billion, and you arrive at shareholders’ equity of $62.15 billion.
So, while its total debt in 2023 fell by $8.55 billion, its debt/equity ratio was still stubbornly high at 1.69 despite having the funds to repurchase $250 billion of its stock over the past three years.
Watch Out for Return on Equity Screens
The other distortion caused by share repurchases is that it creates a higher return on equity (ROE) than if there were no share repurchases.
In 2023, its net income was $97.0 billion. The shareholders’ equity was $62.15 billion for an ROE of 156%. If Apple hadn’t made $77.05 billion in share repurchases in 2023, its shareholders’ equity would have been $139.2 billion, and its ROE would have been 70%, a much more typical ratio for a healthy, growing business.
Only in this case would a screen of stocks with high ROEs still have included Apple. However, companies with poor financials could also make it into the screen due to past share repurchases.
Over the years, the media, including myself, have faithfully covered how less-than-stellar businesses borrow large amounts of capital to buy back their shares. Apple borrows to do this occasionally, but it generates so much cash there is little risk involved, especially when it can get the best possible interest rates on the bonds it issues.
In May, Apple sold $5.25 billion in bonds in five tranches, maturing between 2026 and 2053, at interest rates between 4.0% and 4.85%.
Now, here’s a bad example of debt use.
On November 6, RTX (RTX), the aerospace company, sold $6 billion in bonds in five tranches, maturing between 2026 and 2054, at interest rates between 5.75% and 6.4%. The company is using some of these funds to repay a $10 billion short-term bridge loan it took out to repurchase shares.
“‘RTX continues to demonstrate its penchant for reducing its share count in lieu of reducing its financial leverage,’ wrote Moody’s senior vice president Jonathan Root, in a note. ‘The $10 billion, debt-funded ASR [accelerated share repurchase] is the latest example,’” Bloomberg reported Root’s comments on Nov. 6.
So, once RTX completes its ASR, its ROE will rise considerably despite the added debt due to lower shareholders’ equity. Anyone not knowing this has occurred will assume the higher ROE is because of increased net income.
If they do their homework, they’ll find out that’s not the case. If they don’t, they’re buying shares in a company that fails miserably at Capital Allocation 101.
As Sean Connery’s character in The Untouchables said, “Here endeth the lesson.”
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
