Apple Is Racing Toward a Trillion-Dollar Valuation. How Did It Get Here, and What Does It Mean?

$380 billion in dividends and buybacks

People have always had an unaccountable love of round numbers, especially round numbers attached to money. The "ten-thousand-yuan household." The millionaire. The unicorn, meaning a billion-dollar company. Or the trillion-dollar company.

A trillion is a vague, enormous number — roughly a quarter of the combined market value of the 1,417 companies listed on the Shanghai Stock Exchange, or more than half of Italy's GDP.

At the start of last year, a trillion-dollar company still looked far off. Apple, the most valuable company at the time, was worth only $610 billion. In less than a year and a half, it has grown to $935 billion.

Crossing that symbolic number now looks like a matter of months. The Financial Times ran a whole series on the race to a trillion, and its well-known Lex column judged Apple the likeliest to get there first.

Scott Galloway, a professor at NYU's Stern School of Business who has spent years studying the world's four biggest tech companies and given a series of talks about them, told QDaily in an interview that he still holds his earlier view: Amazon will reach that big number before Apple does.

Amazon, which was still fighting Facebook for fourth place last summer, has already passed Google and Microsoft to become the second most valuable company. Its market value has grown even faster than Apple's, nearly doubling from $400 billion at the start of last year to $796.5 billion today.

Whichever company gets to a trillion first, the milestone marks a change.

Adjusted for inflation, there have been trillion-dollar companies before — but they were a different kind of company

Adjusted for inflation, companies worth a trillion dollars have existed for centuries. The Dutch East India Company was worth roughly $7.9 trillion in the 1640s. Others at similar scale include France's Mississippi Company ($6.5 trillion) and Britain's South Sea Company ($4.3 trillion).

Even in recent years, some companies reached trillion-dollar scale before Apple. Saudi Aramco was worth $4.1 trillion in 2010; PetroChina and the pre-breakup Standard Oil each passed a trillion at various points.

These companies have traits in common. The Dutch East India Company was essentially the advance guard of a colonial empire: it monopolized shipping routes, plundered resources, started wars. Wealth and human lives were both its commodities.

France's Mississippi Company not only monopolized trade along the most important river system in the 18th-century New World; together with Britain's South Sea Company, it produced one of the world's earliest stock market bubbles.

The oil companies each monopolized a producing region or a market. They innovated technologically, but they also enjoyed no shortage of monopoly status handed to them by governments.

Apple, and the companies right behind it in market value — Amazon, Microsoft, Google, Facebook, Alibaba, Tencent — are altogether different. Products and services are the foundation of the empires they built, and those products and services won the personal support of hundreds of millions of users. Whatever their relationships with governments look like today, none of them grew fast on government contracts.

Geopolitics and rent-seeking through political power are no longer prerequisites for building a big business.

Apple most of all. The other tech giants each monopolize at least one market in a particular region: search, social, online retail, enterprise software. Apple monopolizes no market at all, and everything it sells has a cheaper substitute.

The world's most valuable business has moved from war, trade and oil to products and services that give individuals better design and a better experience. That shift alone says something about how far civilization has come.

Apple's run at a trillion isn't only about a strong core business — Cook has also spent $380 billion "playing the stock market"

The main reason its market value keeps climbing is still that the iPhone is enormously profitable. The new phone costs 8,388 yuan and sales show no obvious decline. An annual net profit of more than $60 billion is a powerful stimulant.

The iPhone's prospects still look good. The smartphone business may have hit its growth ceiling and the technology has made no great leap, but no company has truly caught up with Apple, and nobody has found the market that comes after the smartphone. While Android makers squeeze one another and their margins thin out, the iPhone keeps getting more expensive and more profitable — people will pay a premium for something they hold in their hands 24 hours a day.

Wall Street once treated Microsoft and Cisco as trillion-dollar candidates too, but what they rode was the dot-com bubble: at its 1999 peak, Microsoft's market value was 39 times earnings; at its 2000 peak, Cisco's was 127 times. Apple's $935 billion today is about 20 times its annual profit.

The inventions Steve Jobs pushed through are Apple's foundation, but Apple became the world's most valuable company under Tim Cook. Only in 2010 and 2011 did its market value pass ExxonMobil's to take first place.

Besides the profit machine, what has driven Apple's shares up is the return Cook hands to shareholders. One method is the dividend — paying out a share of profits to whoever holds the stock.

The other is the buyback. Apple buys its own shares back off the market, then either cancels them or holds them as treasury stock. Fewer shares circulate while the company's underlying value stays the same, so the share price rises.

Both give investors a direct return, and Wall Street is glad to see both.

Since 2012, Apple has returned $275 billion to shareholders through these two financial instruments. Add the $100 billion buyback program and the $3.7 billion in dividends announced this past May, and Apple will have handed investors $380 billion in cash.

Daniel Ives, chief strategy officer at the consulting firm GBH Insights, wrote in a report early this year that America's big tech companies would buy back $300 billion to $400 billion of stock this year, half of it from Apple.

"We think accelerated buybacks, another dividend increase, and the potential for larger-scale M&A are the three biggest things Apple shareholders can look forward to in 2018," Ives told QDaily.

The $100 billion Apple announced in May went well beyond Wall Street's expectations. After the company reported better-than-expected profits and unveiled the buyback, its shares rose 11.3% in four days, lifting a market value that had been hovering around $820 billion to $900 billion.

Take no risks on businesses you aren't good at, hold a "moat" as hard to challenge as the iPhone, return money to shareholders through dividends and buybacks: Cook's Apple is exactly the sort of company Warren Buffett likes best.

Buffett, who once criticized Jobs for not disclosing his illness to the public in time, first bought into Apple in 2016 and is now its second-largest shareholder.

Pushing up market value pays investors and executives directly — and American financial policy encourages it

Round after round of dividends and buybacks brings round after round of share-price gains, and the executives who direct all of it collect ever richer rewards.

The pay of nearly every big-company executive turns on the share price, and Cook is no exception.

Adjusted for stock splits, Cook has been granted 6.54 million shares of Apple stock since 2012. Valued at the share price on each grant date, that stock was worth $634 million.

As the stock climbed, the value of Cook's holdings doubled, to about $1.3 billion.

Other executives, the CFO among them, take home around $20 million in stock a year — far more than the $1 million to $3 million cash portion of their pay.

Wall Street itself wants executives to push the price as high as they can, because how much both sides make depends on how high it goes. That is also why executive pay leans toward stock rather than cash. When an executive's reputation, job and pay all hang on short-term share performance, few people can resist.

But there is a blurry line here. A buyback pushes the share price up directly, which leaves executives open to suspicion of using buybacks to manipulate the market or trade on inside information — both illegal.

When a company like Apple still posts fine results, a buyback is one legitimate choice. But when a good many large companies keep spending cash on buybacks while their results slide or they lay people off, the problem is plain.

The U.S. Securities and Exchange Commission thought about this too. In 1982 it wrote Rule 10b-18, a "safe harbor" for public companies buying back their own stock, with limits on when, how, at what price and in what volume they may trade.

A buyback that meets those conditions is unlikely to be judged market manipulation, and the risk falls sharply. That has pushed buybacks past dividends to become public companies' first choice for returning money to shareholders.

William Lazonick, an economics professor at the University of Massachusetts Lowell, argues that by drawing a clear line, the policy in effect encourages executives to inflate the share price for their own gain, so long as they stay inside it.

"Rule 10b-18 gives companies a safe harbor against charges of stock market manipulation. But the specific requirements in it amount to telling executives where the line is and not to cross it," Lazonick told QDaily by phone.

By his count, 454 companies in the S&P 500 spent a combined $3.4 trillion on buybacks between 2004 and 2013 — 51% of their total revenue over that stretch — with another 35% going to dividends. In chasing these capital-return programs, he says, the companies followed the short-term profits Wall Street cares about and neglected investment. Lazonick has recommended that the SEC scrap the safe-harbor provision in the buyback rules.

Today there are few large American companies that don't do this. Apple and Google, which once neither paid dividends nor bought back stock, now both ship large sums of profit to Wall Street every year. Trump's tax reform cut the cost of bringing overseas profits and cash reserves home, and that money is one source of Apple's buybacks.

Among the biggest tech companies, only Amazon still does the opposite: it puts as much profit as it can back into the business instead of handing it to shareholders. Amazon has gone six straight years without buying back a share.

Amazon's market value is 256 times its annual profit, a very high number. Apple's is 20 times, Google's 60, Tencent's 43.

The difference is that Wall Street believes Apple should return its profits to shareholders rather than pour them into new businesses — and, at the same time, that Amazon does better spending its money on new businesses than handing cash back.

The benefits of chasing market value are obvious. But should companies do it?

A line the Nobel laureate economist Milton Friedman wrote in the 1970s gets quoted everywhere: a company's only social responsibility is to make a profit, as long as it plays by the rules of the game. It sounds cold, especially now that big companies shape the lives of hundreds of millions of people.

But it is a popular view. Friedman looked at a company's social value with an economist's eye, and his argument rested on a question: if businessmen really do carry a social responsibility beyond making the largest possible profit for shareholders, how are they supposed to know what that responsibility is? Can one person's private judgment settle what is in society's interest? So businessmen should create more profit and raise social efficiency. And the investors in these companies include institutions such as government pension funds — the growth flows back to the public in the end, which is itself a way of delivering social value.

That is also the theoretical basis for the many ways companies return money to shareholders today.

Professor Lazonick disagrees. In 2014 he published a theory of "profits without prosperity" in the Harvard Business Review, which won that year's HBR–McKinsey Award.

"When companies spend profits on buybacks instead of R&D and employee pay, innovation slows and economic growth weakens," Lazonick said. "Executives use trillions of dollars of stock buybacks to please themselves and their big shareholders, and the result is income inequality and stagnant wages for people in the middle."

While Apple pours vast sums into buybacks and dividends, Lazonick says, it overlooks the lowest-paid workers in its own stores, who earn no commission, and it overlooks the conditions of workers at supply-chain companies like Foxconn. He calls the consequences of stock buybacks an economic, social and moral disaster: net investment falls, shareholder value is lost, the capacity to innovate is damaged, workers are exploited, and executive pay soars.

Companies, he argues, should first spend profits on training and retaining employees, then pay taxes so that government has the budget to invest in infrastructure, training and knowledge — and only then pay out whatever dividend is left, if the company is profitable enough.

Before shareholder-value theory took hold in the 1970s, American public companies usually retained their profits or reinvested them. They used retained earnings to make their workforce more competitive, giving workers higher pay and better job security, which contributed to fair, steady economic growth.

After that, maximizing shareholder value became the mainstream idea — one that Jack Welch, the legendary GE chief executive, later called the dumbest idea in the world.

Apple once fit neither camp. Jobs plainly was not turning profit into shareholder value, but he was not a man who talked about social responsibility either. Under him Apple not only made no charitable donations, it joined with Silicon Valley companies including Google and Intel to hold down the pay of employees who might jump between them.

Apple was not a high-paying place by Silicon Valley standards, either. In an interview in the 1980s, Jobs described the working life he wanted to create, one full of satisfaction and purpose: you work harder and longer; you face constant time pressure; you take on responsibilities you never thought you could carry; you don't take vacations, you don't even take weekends off... and none of it bothers you, because you love the work and can't live without it.

That satisfaction and purpose came from the reason the company existed: to bring out products that felt better to use. Every year the whole company's profits and energy were gathered up to create just a few of them.

So why doesn't Apple put that $380 billion into new businesses?

The main buyers of American stocks are institutions. Money returned through dividends and buybacks does not turn straight into cash for houses and boats; it goes immediately into new investments.

By sending money back to shareholders instead of investing it itself, Apple is conceding that investors can earn a higher return putting that money elsewhere than Apple can by putting it into new products.

Apple has become one of Buffett's favorite companies, which is interesting, because Buffett's own company, Berkshire Hathaway, has never paid a dividend. His reason is that the money earns more in his hands than it would if investors took it and bought other stocks.

The logic by which Buffett runs Berkshire Hathaway is in fact closer to Amazon's — or to the Apple that used to be.

Through Jobs's second run at Apple, from 1997 to 2011, the company did not pay investors a cent. Whether in the early days when cash was short or later when quarterly net profit ran into the billions, Apple put more money into products, R&D and marketing.

AB Concentrated US Growth is a roughly $2 billion fund that invests in fast-growing American companies. Its chief investment officer, Jim Tierney, told QDaily that Jobs, in his day, held out against pressure from the capital markets.

"Apple doesn't have to go to the extreme it went to after Jobs came back, but I do think they should put R&D first," Tierney said. "If you pay me a dividend, I might use the money to buy your stock right back, or I might cash out and buy some other company's stock."

One obvious explanation for why Apple isn't spending the money on R&D is that it can't find a new product worth the investment.

The size of an R&D budget doesn't decide whether the R&D works. In the years when the iPhone came out of nowhere and upended the phone market, Apple's R&D spending was a fraction of Nokia's.

Cook has tried to develop more new products, looking for the next iPhone-scale run of growth. It's just that other products, the Apple Watch among them, did not become another iPhone, and the car project is badly stalled. Since the iPhone, Apple has not found a new thing that returns as much.

Some Apple shareholders see it the same way. Hal Eddins, chief analyst at Capital Investment Counsel, puts it more gently: he wants Apple to weigh shareholder returns and strategic investment together. "My assumption is that Apple, at its current level, can't find a strategic investment that would move the company forward. The $100 billion buyback helps right now, but it really doesn't account for the future."

On the iPhone, Apple already does nearly everything that matters itself — from the CPU and GPU to the Face ID facial recognition on the iPhone X and even the AirPods, all of which use chips Apple designed.

The parts Apple doesn't make itself tend to carry more risk. Screens are the example of the moment, in the middle of a technology changeover. The flexible OLED display in the new iPhone was tuned jointly with Samsung rather than bought as a whole production line.

That approach avoids the risk of a generational shift in the technology. JDI, Apple's main screen supplier in earlier years, invested heavily in LCD lines; now that Apple has moved to OLED, JDI's losses are deep enough that the Japanese government standing behind it has begun to question why the company should exist. Had Apple built its own line back then, it would have borne those losses itself.

The corporate structure Jobs left behind also discourages Apple from entering several different kinds of market at once.

At the D8 conference in 2010, Jobs said Apple is the biggest startup on the planet, dedicated to bringing people great products, and that the company therefore has to have the courage to be certain of what a good product truly needs and to drop what doesn't matter.

Compared with the other tech companies worth hundreds of billions, Apple keeps the functional structure more often used by small companies — divisions by function, software, hardware, design, marketing — and concentrates its energy on a handful of products that every executive has to watch. Every other big tech company is organized by business line: Amazon's e-commerce and its AWS cloud business, for instance, run almost entirely apart from each other.

The result is that Apple is better at focusing on doing one thing well (making an iPhone and making an iPad are, at bottom, the same work), while other companies can push several different kinds of product, service, even entirely different business models, forward at the same time.

That is why other companies can't make something like the iPhone. It is also a large part of why Apple, sitting on hundreds of billions in cash, lacks the bandwidth to fund several product lines in a single year. If Apple chose to enter a genuinely different market, it would have to reorganize first.

In short, Apple has not found a new business that can absorb the astonishing profits it generates, so the money goes back to shareholders.

Professor Galloway, who is more bullish on Amazon, described Apple's huge cash returns in an email to QDaily as a young person turning into an "adult."

"A company generating this much cash can't find a better use for it than returning it to shareholders. That tells you it's no longer a young company (which values high growth) but a mature one behaving like an adult (returning cash to shareholders) — a sign of excellent management," Galloway wrote.

In a world that chases youth, "growing up" is itself a problem.

Galloway, who has founded and sold several companies, believes that although Apple gets a far higher return on its R&D than any other tech company, at the pace of the past two years it will sooner or later miss something important. "Think about the most innovative product of the past few years — was it the Apple Watch, the HomePod? No. It was Amazon's Echo devices and their investment in voice technology, which now gives them 70% of the home voice market. More Americans use Amazon Prime than voted in the 2016 presidential election. I think Amazon will eventually introduce some version of Prime that combines artificial intelligence, purchase history and its delivery network to get something to your door before you know you need it."

Meanwhile, after several setbacks with the watch and the car, Apple's new products have all become more concerned with protecting the iPhone.

The Apple Watch is now in its third generation and its direction has changed a great deal. But it still works only paired with an iPhone. So does the HomePod, whose launch went badly: a smart speaker that also has to be paired with an iPhone.

From the Apple Watch to the HomePod to the iMessage service, these are all moats around the iPhone, protecting the iPhone.

The iPod once went out of its way to support Windows PCs, a move that threatened the Mac, Apple's main source of cash at the time, but opened a new market. The iPhone simply erased any reason for the iPod to exist — even though the iPhone's R&D money came from the iPod.

As the moat grows more impregnable, and as it decides whether a company has enough profit to send Wall Street to hold its market value up, the chance that the company will climb out of the moat and find a new path grows smaller.

The steady rise in the prices of existing products shows that when costs go up, Apple would rather raise prices to protect its margin, and with it its market value, than cut prices to win more users.

Seen as a matter of protecting the market value it already has, Apple's caution is correct. The alternatives it is exploring — VR, AR, wearables — all carry real risk, and cars are an extremely risky business. Investing in existing product lines and raising prices to take more profit is a steadier way to lift the share price and the market value.

It's just that someone once said: "We're here to put a dent in the universe."

Lead image from Pexels. Banner: Apple Park, by Carles Rabada on Unsplash