Should Apple Buy Back Shares Or Increase Dividends?

| About: Apple Inc. (AAPL)

It is hardly a secret that the pressure is on Apple (NASDAQ:AAPL) these days. The share price has crashed from $705 down to about $440; nearly a 40% decline from the recent highs. Some folks believe it is a lack of innovation, some think that the current leadership is weak, and some believe the problems have been self-inflicted, me included.

Don't get me wrong, AAPL is a behemoth of a company and has a balance sheet that is virtually unequalled. The company can do whatever it wants. The point of this article is not to debate what Apple needs to do to get back its "mojo," because none of us really have any answers to that.

Would an iWatch solve everything? What about the iTV we have been waiting for? Oh, and we absolutely need a cheap iPhone for the emerging markets right? The point is, we can crunch these issues and the potential numbers until the cows come home, and still not know if anything will help. Why not just focus on what we DO know could help.

All that cash!

Apple Is Not The Only Tech Company With Oodles Of Cash

Granted, this article is about Apple and its cash hoard, but just so we do not overlook others in a similar position, I just want to note that some of the biggest tech names around have more cash than ideas these days.

Wow, Microsoft (NASDAQ:MSFT), Google (NASDAQ:GOOG), Cisco (NASDAQ:CSCO) and Oracle (NASDAQ:ORCL) all have piles of cash, and aside from Google, the other companies are not truly plowing the cash back into their eco-systems to GROW. Oh wait, yes, some of them are making some attempts, like Windows 8, but I have not been seeing anything earth shattering coming from any of these companies with all that cash.

Apple has more than twice the cash as MSFT and we are still waiting for AAPL to actually do something with it. Aside from Google, each of these companies are giving shareholders a dividend. I am going to give GOOG a pass for now, just because they are proving that they are still an enormous growth company. The others? "Feh!" (That is an expression my grandmother used to use when she felt something was insignificant)

Let's take a look at the dividend yields of each of these companies.

AAPL Dividend Yield Chart

With all that cash, and nothing going on with growth, why are these dividend yields so low? Maybe we should look at payout ratios.

AAPL Payout Ratio TTM Chart

Apple has an embarrassingly low payout ratio of less than 6%, while the other 4 companies that pay dividends are within respectability, but still on the cheap side. So, without a clear path for the cash to grow each company, and a rather low payout ratio with existing dividends, maybe these companies, specifically Apple, are buying (or should be) their own shares back, to give shareholder value.

Let's take a look at the share price to book value to see if buyback plans are actually worthwhile, in terms of shareholder value.

AAPL Price / Book Value Chart

As you can see, none of the share prices of these companies are close to book value. Looking directly at Apple, the ratio is 3.16 (316% of net asset value)! It seems to me that most market "experts" jump at the chance to announce share buy backs when the share price is BELOW book, just as Bank of America (NYSE:BAC) did just recently (foregoing a dividend hike of course). BAC is selling at about a 35% discount to book value, so an argument can be made that it is the right move.

So, What Should Apple Do?

Even the esteemed "Oracle of Omaha," Warren Buffett prefers share repurchases than dividends, but only if the share price is at or below 120% of net asset value.

Mr. Buffett's program at Berkshire Hathaway is a model-and investors should look for other buyback programs that follow suit.

Mr. Buffett is disciplined on price. He will buy back company stock, he says, only if it is trading for 120% or less of the per-share net asset value, a level he deems a bargain for his remaining stockholders.

So how does Buffett come to the conclusion that AAPL should buy back shares rather than increase dividends?

Buffett suggests that increasing Apple's stock buyback would be the most prudent use of the company's cash and notes that he had previously discussed the possibility with Steve Jobs.

"I don't own any Apple and I haven't, though I did talk with Steve Jobs a few years ago about what they might do with the cash. [...]

When Steve called me, I said, Is your stock cheap? He said, yes. I said, Do you have more cash than you need? He said, a little. [laughs] I said, then buy back your stock."

At a 3.16 price-to-book, how would buying back shares at more than 3 times the current net asset value add ANYTHING to shareholder value? I wonder if Warren would suggest that to HIS board, if the price-to-book was 3.16? Is Apple going to buy back 50%-75% of all outstanding shares?

The Bottom Line

Apple is going to announce 2nd quarter earnings on April 23rd, with a conference call scheduled at 5:00PM East Coast time. I am not sure how the earnings will go, but whether they are fair to neutral or not, I believe that the only way Wall Street, and investors, will embrace Apple stock again, is if they raise the dividends they now pay, perhaps by at least doubling the current yield.

If Apple decides to buy back shares, I do not see the stock increasing to any extent, and could remain range bound until management wakes up and realizes what matters to shareholders.

Disclosure: I am long AAPL, GOOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.