Apple (AAPL) is not only the most valuable company in the world and a world-class hardware manufacturer, the company also is a showcase in corporate capital allocation.

Company Overview           

Apple, which was founded in the 1970s, has turned into a hardware giant that offers smartphones, tablets, computers, media devices, etc. On top of that Apple has grown its services segment, which includes iTunes, Apple Pay, the App Store, etc. into a sizeable business that grosses billions a year.

During the third quarter Apple was able to generate sales of $53 billion, a 17% increase year over year. The company earned $2.34 per share during the same quarter, an increase of 40% year over year.

Growth Prospects And Capital Allocation            

The iPhone is Apple’s most important product by far, when it comes to revenue generation as well as when it comes to profit generation. The global smartphone market is mostly saturated, but Apple benefits from two trends: Due to bigger sizes and additional features the company is able to demand higher prices per iPhone, which results in higher average selling prices compared to previous years. Rising incomes in many emerging countries also allow Apple to capture market share globally, as more and more consumers are able to acquire Apple’s higher-priced products.

Apple’s services segment continues to grow at a highly compelling rate, during the most recent quarter the segment saw a 31% sales increase, the annual run rate is now close to $40 billion. As the amount of iPhone users around the globe continues to rise, and as Apple is adding new features and services regularly, investors can expect ongoing growth from this segment.

Apple generates massive cash flows: During the last fiscal year its operating cash flows totaled $64 billion. In general, there are five ways of allocating capital that corporations can chose from:

• Mergers and acquisitions
• Investments into organic growth
• Share repurchases
• Debt reduction
• Dividend payments

Apple’s management is adept in finding the best ways to employ the company’s massive cash flows, several of the above strategies are pursued at the same time. Apple invests into organic growth, primarily via a high pace of R&D spending. Apple has not made many major acquisitions, but when management finds a target that fits its strategy, it is willing to take it over. One such example is Apple’s recent deal to acquire music app operator Shazam, which is a good fit for Apple’s music strategy and which will strengthen Apple’s services segment further.

Apple is not paying down debt at a massive scale, primarily due to the fact that the company already has a high net-cash position, but Apple spends a lot of cash on shareholder returns. In addition to offering regular dividend increases, Apple has been repurchasing shares for many billions of dollars. Earlier this year the company announced a $100 billion addition to its share repurchase authorization, which is enough to lower the share count by ~10%.

Apple’s management therefore is very flexible in allocating capital, always looking for ways to employ portions of the company’s massive cash flows to generate attractive risk-adjusted returns. Management’s strategy has been highly beneficial for Apple’s shareholders, which saw attractive total returns in the past.

Final Thoughts

Apple’s massive cash flows allow management to pursue different projects at the same time: Organic growth investments, acquisitions that fit Apple’s long-term strategy, and shareholder returns via dividends and share repurchases.

Investors can expect that Apple will allocate capital to each of these measures in the future as well, and it seems likely that this will result in compelling total returns in the future, too.

Apple’s shares are trading slightly above the long-term median valuation right now, though, which is why it might be advantageous to wait for a lower entry price.