Beset by critics and bedeviled by a declining stock price, Tim Cook, the company’s beleaguered chief executive, announced a big stock buyback and a substantial dividend increase. The market did not, however, respond by pushing up Apple’s stock price. But these actions do raise the question why Apple (APPL), which has too much cash on its books and is trying desperately to return cash to its shareholders, a company unlikely ever again to need to raise money in the public markets, should worry so much about its share price anyway?
And it’s not just Apple. CEOs are obsessed with their companies’ stock price. So companies faced with falling shares frequently announce share buybacks, even though research shows (pdf) that many such buybacks are not completely consummated. Other data suggest (pdf) that companies’ market timing is often quite off, with the businesses buying their shares at high prices and issuing them at low prices, a buy high, sell low strategy that benefits no one. Meanwhile, CEOs spend lots of time doing analyst presentations, conference calls, and the increasingly ubiquitous industry investor conferences where they sell—not their products or services to real customers, but their investment attractiveness to kibbutzers.
Although many people believe that total shareholder return (TSR), which consists of changes in stock price and dividend payouts, actually reflects something about the quality of the company’s management, I am far from convinced. Justin Fox, editorial director of the Harvard Business Review group, wrote a book, The Myth of the Rational Market, that pretty thoroughly debunked the idea that stock prices efficiently incorporate all available information instantaneously to provide accurate signals about a company’s (and by implication, its management’s) performance.
So Apple, with trailing 12-month sales of $164 billion in sales, $42 billion in profits, and $57 billion in operating cash flow, according to Yahoo! (YHOO), dwarfs its high-tech competitors, not just the inept Hewlett-Packard (HPQ) and dying Dell (DELL), but Microsoft (MSFT)and Google (GOOG), as well. Think about those numbers—Apple turns approximately a third of its sales into cash flow, a ratio that would be the envy not just of retailers but the of pharmaceutical industry, even as many bemoan the company’s performance.
As research (pdf) by Stanford accounting professors Ron Kasznik and Maureen McNichols has shown, stock price returns are related to whether companies either beat or fall short of expectations, and earnings surprises can be a more important determinant of a stock’s price than actual operating performance. Holding aside the perversity of this empirically demonstrated fact, as Toronto business school dean Roger Martin perceptively noted a while back, the current regime of “TSR above all else” seems to reward senior executives for, to use a sports analogy, “beating the spread.” Although few baseball managers or football coaches would hold their jobs long if they had horrible won-loss records but managed to exceed gruesomely low expectations, that is precisely what goes on in industry all the time. Moreover, because of the enormous and perverse incentives to game the system, virtually all professional sports have banned players and managers from participating in the expectations market, and when such bans fail, there are often prominent scandals. Meanwhile, in business, executives are encouraged or even compelled to play in an expectations market, with people being surprised when the leaders game the system.
Don’t get me wrong. I’m all for underpromising and overdelivering in jobs at all levels—it’s a nice way to build your managerial reputation. But we ought not to confuse image management with substantive performance. Some of the best-managed companies have share prices that don’t move much because their superior management and results are already reflected in their stock price. (Southwest Airlines (LUV) is one example.) That fact does not negate their outstanding results in the least.
Put simply, executives should spend more time on product development and customers and less time worrying about something (their stock price) that is more outside their control. And in thinking about Apple or any other company, observers should focus more on profitability and cash flows. After all, that’s what Warren Buffet does.