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Apple's (NASDAQ:AAPL) well-publicized earnings report and subsequent dividend and buyback announcement has sent shares soaring since the news was made public. Apple now yields close to 3% and has committed to buying back a record amount of shares in order to reduce the float. The implications of these actions for dividend investors are enormous. This article will examine Apple's value now considering the new information regarding the dividend and buybacks.

To do this, we'll use a DCF-type approach that requires some assumptions: 1) a discount rate of 10%, 2) a dividend growth rate of 12% per annum, 3) a perpetual growth rate of 3%, and 4) earnings estimates matched to the current price. I have used what I consider to be reasonable estimates; you may disagree with some or all of my numbers, but keep in mind all forecasting is subject to conjecture and risk.

First, I used 3% earnings growth in order to illustrate exactly what is being priced into Apple shares today. For instance, Yahoo Finance has a five-year growth rate of 20.88%, but I am illustrating the effect of the negative sentiment regarding Apple's prospects for growth. Next, I chose 12% as the dividend growth rate for two reasons. Apple's cash flow and new debt offerings will allow it to buy back an enormous amount of shares, well over 100 million at current prices, over the next couple of years. This will make paying the dividend much easier as each share that is repurchased saves the company $12.20 annually. Also, with Apple having a modest R&D and SG&A expenditure model, it has plenty of free cash to pay ever-increasing dividends.

2013

2014

2015

2016

2017

2018

Earnings Forecast

Reported earnings per share

$39.97

$44.25

$45.57

$46.94

$48.35

x(1+Forecasted earnings growth)

10.70%

3.00%

3.00%

3.00%

3.00%

Forecasted earnings per share

$39.97

$44.25

$45.57

$46.94

$48.35

$49.80

Equity Book Value Forecasts

Equity book value at beginning of year

$125.86

$153.63

$184.21

$214.48

$244.28

$273.44

Earnings per share

$39.97

$44.25

$45.57

$46.94

$48.35

$49.80

-Dividends per share

$12.20

$13.66

$15.30

$17.14

$19.20

$21.50

Equity book value at end of year

$125.86

$153.63

$184.21

$214.48

$244.28

$273.44

$301.74

x Equity cost of capital

10.00%

10.00%

10.00%

10.00%

10.00%

10.00%

Normal earnings

$15.36

$18.42

$21.45

$24.43

$27.34

$30.17

Forecast EPS

$39.97

$44.25

$45.57

$46.94

$48.35

$49.80

-Normal earnings

$15.36

$18.42

$21.45

$24.43

$27.34

$30.17

Abnormal earnings

$24.61

$25.83

$24.13

$22.51

$21.01

$19.63

x discount factor (10%)

0.909

0.826

0.751

0.683

0.621

0.564

Abnormal earnings disc to present

$22.37

$21.33

$18.12

$15.38

$13.04

$11.07

Abnormal earnings in year +6

$11.07

Assumed long-term growth rate

3.00%

Value of terminal year

$380.05

Estimated share price

Sum of discounted AE over horizon

$101.31

+PV of terminal year AE

$214.35

PV of all AE

$315.65

+Current equity book value

$125.86

Estimated Current share price

$441.51

According to my model, Apple is currently priced for about 3% perpetual earnings growth after 2013 at the current price of $432. It is important to note that this model, for conservatism's sake, assumes no buybacks. Therefore, Apple's value under this low-growth scenario is something like 12%-15% percent higher than the model shows. However, again, to be conservative we are assuming the 100-million-plus shares that are going to be bought back at some point in the near future won't be; this alone offers significant potential upside to the fair value price.

Now, for the most important part of the model, we can see that my dividend forecast of 12% yearly growth produces an estimated $99 of dividends between now and 2018. This represents 23% of the current share price. While there are higher-yielding, pure income stocks out there, the fact that Apple can obviously afford even 12% dividend growth should be encouraging for dividend growth investors.

While I don't find the payout ratio to be useful in any way, many investors and management of large corporations do. Therefore, it is instructive to understand what the payout ratio would be for Apple under the scenario I just laid out. If Apple meets its estimated $40 per share in earnings this year and pays $12.20 in dividends, its payout ratio would be about 30%. If the dividend grows at 12% and Apple can only muster 3% EPS growth for the next six years, the payout ratio in 2018 would still only be 43%!

This is what I consider to be a worst-case scenario for Apple earnings given the fact that the company is still in a dominant position in its major markets and the enormity of the buyback program that was just announced. Unless there is some drastic change in consumer preferences or Apple can't innovate, I don't see how this scenario could be possible. However, for the sake of being conservative, we can assume this is what will happen. If Apple only earns $50 per share in 2018 and maintains its forward P/E of 9.7, a price of $485 is implied. That price is about 12% higher than where shares trade today. While that is certainly not a gangbusters return, keep in mind you'd collect 23% of the share price in dividends.

Yesterday, I wrote a piece in which I posited that Apple will slowly become irrelevant and lose market share, revenue and profits if it fails to recognize changes in consumer preferences. I won't rehash the argument but the point is that consumers are trending toward progressively larger smartphones and Apple is essentially ignoring those consumers. If Apple can't find a way to innovate, whether it is with different form factors of iPhones or some new product we don't know about yet, there could be some downside to my forecast. However, given the sheer size of the share repurchases and the dividend payments, shares are probably very safe around $400 -- unless some catastrophe arises. I don't think this will happen, but it doesn't mean that it won't. This is simply something to keep in mind if you are long. It is not a present threat, but it could be several years from now if Apple continues to hide its head in the sand and ignore what consumers want.

While I think Apple needs to begin innovating again, the value that is present right now in shares is hard to ignore. The company is set to repurchase roughly 139 million shares at current prices, or about 15% of the float. In addition, the dividend is very strong already and will no doubt become stronger. After the initial euphoria of the announcement has worn off and shares trade down a bit, it could be a great time to initiate a new position or add shares if you're already long. The combination of buybacks and dividends has put a floor on shares, even if Apple can't innovate.

Source: Apple: Dividend Growth Investor's Dream?