When we think of people, places, things, and institutions, our minds form an image and information which contradicts that image and creates "cognitive dissonance", which is often resolved by the suppression of the new information. But, in the real world, washed up starting pitchers become star relief pitchers, battleships in World War 2 began as queens of their navies and ended as useful anti-aircraft platforms, and bombshell actresses transition into becoming talented character actresses all the time. I love movies which depict a young man's transition into maturity; one of my favorite movie characters of all time is Howard Eppis in The Big Fix, the campus radical on the run who becomes an advertising executive. Thus, "growth stocks" can become "value stocks" and, in today's yield-oriented market, that means they must become reliable sources of dividend yield. The problem is that investors are not movie audiences or sports fans; they insist on "proof" before accepting the fact that a growth stock which has disappointed them can emerge anew as a value stock.
I have put together some very revealing numbers comparing three aging "growth stocks" with two established "dividend champions." The table below provides Friday's closing price, the price earnings ratio based on current year's estimated earnings, current dividend yield, and pay out ratio (dividends as a percent of earnings) for Apple (AAPL), Microsoft (MSFT), Cisco (CSCO), Procter & Gamble (PG) and Coca-Cola (KO). The data is from Yahoo Financial; the current year earnings estimates are based on consensus estimates on Yahoo Financial.
So far, the analysis suggests that the dividends of AAPL, MSFT, and CSCO are more comfortably supported by earnings than are those of PG and KO. Of course, it will be argued that PG and KO have much more stable earnings and that, therefore, there is much less risk of an earnings decline than there is with our tech trio. After all, the markets for Tide and Diet Coke are more stable and enduring than the market for the latest iPhone. In addition, an argument can be made that the impressive dividend history of KO and PG - extending back beyond the birth of almost every active investor - deserves enormous weight and provides an investor increased confidence in the stability of future dividends. And, of course, it is stability and assurance of continuity in dividends that is very important to today's investors moving into stocks in search of better yields than can be had in the fixed income sector.
For that reason, I will throw another factor into the mix - balance sheet cash. The table below provides, for all five companies, gross balance sheet cash per share, net balance sheet cash per share and three calculations of dividend sustainability. Q1 is the number of quarterly dividends that could be paid out of current gross balance sheet cash. Q2 is the number of quarterly dividend payments that could be paid using only 50% of current gross balance sheet cash. Q3 is the number of quarterly dividend payments that could be paid using only 50% of net balance sheet cash. Balance sheet data is derived from SEC filings of each company [Microsoft, Apple, Cisco, Procter & Gamble, Coca-Cola].
AAPL, MSFT, and CSCO all have enough balance sheet cash to sustain dividends for a long time. I am 68 years old and AAPL may have enough cash to keep paying its dividends for the rest of my life even if it doesn't earn another cent. Even using the conservative calculations of Q3 and assuming that cash is used for other purposes such as acquisitions and buy backs, AAPL could keep on paying dividends for nearly 7 years and CSCO nearly 5 without ever posting positive earnings.
Of course, this is somewhat of an apples and oranges comparison. It is difficult to put a value on the demonstrated long-term stability of increasing earnings and increasing dividends that PG and KO have attained. There is no neat formula for translating the advantages of balance sheet cash into a comparable metric so that MSFT can be measured on a scale against PG or AAPL can be compared with KO. In each case, the two companies have nearly equal dividend yields but very different histories and business models. Perhaps, they are so different that no real comparison is possible.
There is, however, one consideration which the above data suggests may become relevant. The low payout ratios and the huge balance sheet cash hoards of AAPL, MSFT, and CSCO suggest that substantial dividend increases are not only possible but very likely. And, if MSFT continues trading at the same dividend yield as PG and AAPL continues trading at the same dividend yield as KO, then MSFT and AAPL are also likely to move up (on a relative basis) in price.
It is hard to think of MSFT, AAPL and CSCO as reliable, steady eddy dividend stocks, just as it is hard to think about Tom Sawyer as a middle-aged judge, Howard Eppis as part of Mad Men, Michelle Pfeiffer as a talented character actress in her 50's, and the battleship Missouri as an anti-aircraft platform primarily useful in defending aircraft carriers. It is, of course, the difficulty in dispelling past images that have now become irrelevant that creates occasional bargains in an otherwise efficient market. But "yield hunger" has become the dominant force in the market and, as these companies increase their dividends, investors are likely to push share prices up as well.
I am long AAPL, MSFT and CSCO. By the way, I am also long PG and KO and I have nothing against these stocks. Investors in PG and KO will do a lot better than almost any investors pursuing fixed income strategies from here. But I am also convinced that investors in AAPL, MSFT and CSCO will do even better.