There are two ways that corporations can return capital to shareholders:

• Dividends
• Share Repurchases

Adding these two capital return methods together on a per-share basis and dividing by a company’s current stock price gives shareholder yield, a proxy for the ‘shareholder-friendliness‘ of a company’s management team.

Dividend payments are straightforward and well understood by most investors. Conversely, share repurchases are a very misunderstood tool used by companies to return cash to shareholders.

This is particularly unfortunate because share repurchases are actually much more tax efficient than dividend payments. Dividend payments are subject to double taxation (tax on corporate net income, then tax on personal dividends), while share repurchases are only taxed once.

Share repurchase also have a greater long-term effect on corporate net worth, since any dividends that would be paid on repurchased common shares are eliminated, resulting in meaningful cost savings in the long run.

With all this in mind, it’s clear that share repurchases can have a profound effect on long-term shareholder returns.

In recent years, there is perhaps no greater example of a successful share repurchase program than Apple’s (AAPL ) ongoing capital return program.

Apple’s buyback is magnificent in both magnitude and execution. The company’s management team has repurchased stock at persistently low valuations, often financing the purchases using attractively-priced debt to be repaid later using the company’s robust free cash flow.

Apple’s repurchase plan has been very well done and provides an insightful case study into corporate governance and capital allocation.

This article will analyze Apple’s capital return program in detail.

A Quantitative Summary

Apple’s current capital return program was initiated in 2013.

To date, the company has returned $211 billion of capital to shareholders through a combination of dividend payments and share repurchases. During this time, the company’s cash account has grown from $121 billion to $257 billion.

The following table provides a detailed breakdown of the magnitude and composition of Apple’s capital return program by reporting period.

Source: Apple Investor Relations

There are a number of remarkable observations that can be made from this table.

First of all, Apple’s current share repurchase program has already driven the company to repurchase $151 billion of the company’s current stock outstanding.

For context, Apple has a current market capitalization of $768 billion, which implies that Apple has already spent approximately 20% of its current market cap on share repurchases.

In reality, the effect on Apple’s outstanding share count would be materially higher than 20% because many of the repurchased shares were purchased at prices significantly lower than Apple’s current stock price.

For instance, consider the following breakdown of Apple’s fiscal 2016 share repurchases by time period:

Source: Apple 2016 10-K, page 19

During the three time periods shown above, Apple’s average price paid per share was $96.83, $108.11, and $109.71. The company’s current stock price is ~$149 and it has been as high as $155 recently, which means that the ‘return’ on these repurchased shares has been significant.

Another impressive metric shown in the first table is the sheer amount that Apple has paid in dividends – $54 billion to date. At current market prices, this amounts to approximately 7% of the company’s market capitalization.

Other than the dollar value of repurchased shares and dividends paid, there are two other metrics we can use to appreciate the impressive magnitude of Apple’s share repurchase program.

The first is the change in Apple’s share count over time. This can be seen below.

Source: YCharts

In the above chart, you can see a deliberate shift in Apple’s balance sheet management strategy. Until 2011, Apple’s share count was regularly expanding, although usually by low-single-digit percentages.

Once 2013 hit and Apple’s free cash flow built its cash account to prohibitive levels, the company began focusing on reducing its share count and returning capital to shareholders.

Another metric to consider is the growth differential between Apple’s company-wide net income and its earnings-per-share. When a company is actively repurchasing shares, earnings-per-share growth will outpace company-wide net income growth because shares outstanding (the denominator in earnings-per-share) is decreasing.

The cumulative growth in trailing-twelve-month net income and adjusted earnings-per-share since the inception of the current capital return program can be seen below.

Source: YCharts

Apple’s company-wide net income has increased by a cumulative 9.5% while its adjusted earnings-per-share has increased by 36%. This shows the impressive power that share repurchases can have on per-share intrinsic value.

Importantly, Apple’s capital return program shows no sign of slowing down.

In the company’s second quarter earnings release, Apple actually expanded its capital return program to $300 billion (up from $250 billion previously). Here’s an excerpt from the company’s press release:

“We generated strong operating cash flow of $12.5 billion and returned over $10 billion to our investors in the March quarter,” said Luca Maestri, Apple’s CFO. “Given the strength of our business and our confidence in our future, we are happy to announce another $50 billion increase to our capital return program today.”

As part of the latest update to the program, the Board has increased its share repurchase authorization to $210 billion from the $175 billion level announced a year ago. The Company also expects to continue to net-share-settle vesting restricted stock units.

The Board has approved a 10.5% increase to the Company’s quarterly dividend, and has declared a dividend of $0.63 per share of the Company’s common stock, payable on May 18, 2017 to shareholders of record as of the close of business on May 15, 2017.

From the inception of its capital return program in August 2012 through March 2017, Apple has returned over $211 billion to shareholders, including $151 billion in share repurchases.”

Apple remains committed to returning its cash hoard to its shareholders. Moving forward, this will have a substantial impact on the company’s shareholder returns.

To illustrate this, the following section analyzes the three ways that Apple’s share repurchase program has positively impact the company’s per-share intrinsic value.

The Impact on Apple’s Per-Share Intrinsic Value

Apple’s share repurchase program has had a tremendous impact on the company’s per-share intrinsic value.

The effect is two-fold.

First, Apple shareholders have benefitted from faster increases in the company’s per-share financial performance figures.

Share repurchases have the effect of boosting earnings-per-share, revenues-per-share, book-value-per-share, and free-cash-flow-per-share even if company-wide performance remains constant. If company-wide performance is improving, then share repurchases increase the pace of growth on a per-share basis.

There is a second, more subtle reason why Apple’s share repurchase program has been so successful. It is because much of the buyback has been financed with debt.

For some investors, this may be puzzling. Apple has the largest cash hoard of any company in the United States. Why take on unnecessary debt to repurchase share? Isn’t that risky?

There are concrete reasons why Apple uses debt to repurchase stock.

First of all, the vast majority of the company’s cash and equivalents are held outside of the U.S. This means that a hefty repatriation tax would be incurred if the money was brought back to the United States.

Secondly, Apple benefits tremendously from being seen as a very creditworthy institution. Accordingly, the interest rate it pays on its debt is very low.

The extraordinary part of this strategy can only be noted when you see the differential between Apple’s dividend yield and the interest it pays on its outstanding debt.

For a small case study, consider Apple’s debt issuances in the fourth quarter of 2016. The company issued floating-rate and fixed-rate notes with effective interest rates ranging from 0.91% to 3.86%.

For context, Apple’s current dividend yield is 1.7%. This means that shares repurchased using proceeds from the 2019 or 2021 debt offering (with interest rates of 0.91%, 1.13%, and 1.40%) actually saved the company money each year on a pre-tax basis.

Source: Apple 2016 10-K Filing, page 59

On a company-wide basis, it is likely that Apple’s weighted average interest expense is actually slightly higher than its dividend yield, despite the company’s rock-solid balance sheet.

We can compute the company’s weighted average interest rate by dividing its total interest expense by its total debt level.

In 2016, Apple has total interest expenses of $1.456 billion, or $1.5 billion to the tenth’s decimal place.

Source: Apple 2016 10-K, page 27

During the same financial reporting period, Apple reported total term debt of $78.9 billion (shown below).

Source: Apple 2016 10-K, page 21

Dividing Apple’s annual interest expense ($1.5 billion) by its year-end total term debt count ($78.9 billion) gives us 1.9%, an approximate measure of the company’s weighted average interest rate.

Note that estimating a company’s weighted average interest rate using this method will understate the interest rate if the debt level is growing (which is the case for Apple).

While we can’t know Apple’s exact weighted average interest rate, we can say with certainty that the company’s incremental interest expense will be higher than its future dividend savings on any share repurchases financed using debt. So why is the company using debt to repurchase shares?

There are three broad reasons.

First, the current U.S. tax code combined with GAAP accounting treatments mean that companies are highly incentivized to finance their activities (including share repurchases) using debt.

Interest expenses are deducted from revenues to determine net income, while dividend payments are not.

This means that if Apple can replace dividend payments with debt payments on a one-to-one basis, it will actually have higher net income on an after-tax basis thanks to the tax deductibility of interest expenses.

The exact financial impact of this accounting phenomenon cannot be understood without knowing Apple’s effective tax rate. As shown below, Apple has paid a tax rate of ~26%, on average, over the past three fiscal years.

Source: Apple 2016 10-K, page 28

With that in mind, the following step-down table shows the tax & interest savings created by Apple when it finances share repurchases with debt (assumptions include a 1.7% dividend yield, 1.9% interest rate on additional debt, and 26% effective tax rate).

After accounting for tax and dividend savings, Apple saves about $2.9 for every $1,000 allocated to its share repurchase program.

While that is reason enough to execute this massive buyback program, there are yet two other benefits to Apple’s capital return initiative.

The first is, unsurprisingly, the benefits of having a lower number of share outstanding. As mentioned previously in this article, this will increase important per-share yardsticks of intrinsic value, including earnings-per-share, revenue-per-share, book-value-per-share, and free-cash-flow-per-share.

The last advantage to Apple’s capital return program is its increasing benefits if the company ever increases its dividend.

Importantly, Apple does not need to raise its dividend in order for the share repurchase plan to be worthwhile. The data provided above shows that Apple will save money using this share repurchase program if its dividend payments remain constant.

With that said, a dividend freeze from today’s level is improbable. In fact, given its massive cash hoard and industry-leading position in the consumer electronics industry, Apple is highly likely to grow its dividend at a relatively high rate looking ahead.

This means that Apple’s future dividend savings will continue to grow, while the interest payments on its new debt will not. Over time, this spread between dividends and interest payments will make Apple’s share repurchase program even more fulfilling for the company and its shareholders.

Quantitatively, Apple’s share repurchase program has had a strong effect on the company’s per-share intrinsic value.

The next section describes the program’s effect on Apple’s industry-leading cash account.

Apple’s Stubborn Cash Hoard

Apple’s capital return program has seen the company return more than $200 billion to its shareholders through dividend payments and share repurchases.

Because of the eye-popping magnitude of this figure, one would think that Apple’s remarkable capital return plan would eat away at its cash account over time.

Surprisingly, the company’s dividends and share repurchases have been unable to put a dent in its industry-leading cash account. In fact, Apple has actually more than doubled its cash account since the inception of the capital return program, growing it from $121 billion to $257 billion.

This is primarily because the vast majority of Apple’s cash is held in overseas accounts. In order to return this capital to Apple’s U.S. headquarters – which is required if this money is used for dividends or share repurchases – Apple must pay an onerous 35% tax rate (with a tax credit applied for any taxes already paid to international tax authorities).

This incentivizes Apple to keep its cash overseas, and fund its capital return with debt. Case-in-point:

“As of September 24, 2016 and September 26, 2015, $216.0 billion and $186.9 billion, respectively, of the Company’s cash, cash equivalentsand marketable securities were held by foreign subsidiaries and are generally based in U.S.dollar-denominated holdings. Amounts held by foreign subsidiaries are generally subject to U.S. income taxation on repatriation to the U.S.”

Source: Apple 2016 10-K, page 55

Fortunately for Apple, President Trump has discussed implementing a 10% one-time ‘repatriation tax holiday’, which would significantly lower Apple’s tax basis on repatriated funds. I suspect this holiday would trigger an immediate transfer of Apple’s international funds to domestic accounts.

It is difficult to know exactly what Apple would do with $200 billion+ of fresh, deployable capital. I do not have access to the inner working of Apple as a corporation. I do have access to management’s statements during public conference calls.

In January, Apple CEO Tim Cook said the following with regards to Apple’s reaction to repatriation tax reform:

“I am optimistic given what I’m hearing that there would likely be some sort of tax reform this year, and it does seem like there are people in both parties that would favor repatriation as a part of that. So I think that’s very good for the country and good for Apple. What we would do with it, let’s wait and see exactly what it is. But as I said before, we are always looking at acquisitions. We acquired 15 to 20 companies per year for the last four years. And we look for companies of all sizes, and there’s not a size that we would not do based on just the size of it.”

Repaying debt or executing additional share repurchases were not named among the possibilities for future repatriated funds (although the analyst’s question was about M&A specifically).

I suspect that if a repatriation holiday were to occur, Apple’s behavior towards its debt pile would differ based on movements in interest rates.

If interest rates remain low, Apple will likely refinance existing debt with additional debt once it matures.

If interest rates rise noticeably, Apple will likely repay existing debt with cash, but only once the existing debt matures. The vast majority of Apple’s debt is fixed-rate, meaning the company will not incur any additional interest expense just because market interest rates rise.

All said, I believe that a tax repatriation holiday would result in more of the same for Apple – significant share repurchases and dividend payments, with the stock buybacks financed partially (or mostly) with low-interest-rate debt.

Final Thoughts

Apple’s capital return program is one of the largest and most well-executed programs in today’s market.

The company’s intelligent use of low-interest-rate debt combined with its discipline in buying back stock at low prices have both contributed to the company’s growth in per-share intrinsic value over time.

Investors should take note of Apple’s intelligent capital allocation. Any other businesses that exhibit such discipline in capital return likely merit further research and even potential investment. For now, Apple remains the best-of-breed when it comes to very large, well-executed buyback program.