Apple (AAPL) investors have seen their shares taken on a wild ride over the past couple of years. We're all aware of the operational issues and opportunities facing the tech giant and that is not what this article is about. However, part of the transformation Apple has been going through for the past few years is the movement towards a mature, dividend paying stock instead of a rapid growth company. With Apple now paying a sizable dividend, this article will examine the potential for dividend investors' capital returns based on Apple's operating performance in the recent past and going forward.
To begin, we'll take a look at Apple's net income in relation to its dividends paid for the past five fiscal years. In doing so, we are satisfying the propensity for dividend investors to examine the payout ratio for a company. In essence, the payout ratio says how much of a company's net income is paid out in dividends. While this ratio is utter nonsense, we'll take a look at it now as the payout ratio permeates virtually all dividend stock discussions.
Now, 2009 to 2011 show only net income because, as we all know, Apple didn't begin to pay a dividend (again) until fiscal 2012. However, the chart is still instructive as it shows the meteoric rise in net income Apple experienced in just the past five years and the falloff in fiscal 2013. So for the purposes of this particular discussion, we are really interested in 2013's numbers. As we can see, Apple paid just over $10 billion in dividends but made roughly $37 billion in the fiscal year. This means Apple is amply covering its dividend, share repurchases and anything else it wants with the net income it earns.
However, as I stated in the introduction, the payout ratio is nonsense. Net income is simply an accounting metric intended for calculating income tax liability and for easier comparison to peer companies. Net income is not cash and cannot be used for anything tangible. In other words, what we're really interested in is the company's cash flow. In light of that information, Apple's cash flow information is below.
While this chart looks very similar to the first one there are subtle differences that allow us to achieve some additional insight into Apple's ability to pay dividends in the future. For example, if we just look at fiscal 2013's numbers, the dividend is of course the same but look at the FCF number; we see close to $45 billion in FCF in comparison to $37 billion in net income. That is what I mean when I say the payout ratio is meaningless; not only can you not pay a dividend with net income but it is also generally a poor indicator of a company's ability to do so. There is so much noise in net income, such as depreciation, that as a measure of a company's profitability, it is decent at best. However, FCF is difficult to manipulate and as a result, is a better gauge of a company's ability to pay for things, such as dividends. As you can see, Apple's ability to pay dividends is much better than net income or the payout ratio would suggest.
If we take a look at the traditional payout ratio versus what I call the FCF coverage ratio, we see exactly what I'm referring to when I say Apple is actually much better off than the payout ratio would suggest. Note: I eliminated pre-2012 years in this chart because they were all zero as Apple didn't resume paying a dividend until fiscal 2012.
What we see is interesting in two ways. First off, the scale here is ridiculously low. Apple's payout ratio wasn't even 30% in fiscal 2013, indicating that the company is well positioned to increase the dividend payout in future years. Second, we can see that last year showed us the reason we need to be cognizant of a company's ability to cover its dividend payments with FCF; while 448 basis points doesn't sound like a lot, when you're talking in the tens of billions of dollars, every basis point counts.
So the billion dollar question is what exactly does this mean for Apple shareholders? I think it shows a couple of things. First, it puts into context just how ridiculously profitable Apple is. In just the dataset I pulled for this article we see Apple's net income rise from $9 billion to $37 billion. In addition, FCF has risen from $9 billion to $44 billion in that same time period. That means there is a lot of money left over at the end of the year to pay for things like acquisitions, R&D, share repurchases and dividends. Just how much could be left up to interpretation but we'll take a shot here at forecasting how much of a dividend payout Apple can comfortably afford and what it would mean for the yield on Apple shares.
I thought it may be instructive to understand how Apple stacks up against some other large dividend payers in terms of the amount of dividends paid versus FCF and the results are below. Note: all data are from Morningstar.
- Cisco (CSCO)-29%
- Microsoft (MSFT)-33%
- IBM (IBM)-29%
- Coca-Cola (KO)-59%
- Procter & Gamble (PG)-65%
- Johnson & Johnson (JNJ)-53%
You can easily see I've chosen three tech dividend payers and three consumer dividend payers and the results are very clear; tech dividend payers often return less capital to shareholders via dividends as I've defined it. The consumer companies I've chosen are comfortable with paying ~60% of their FCF in dividends each year. Why this is isn't important but that the relationship exists is important. The point is, with Apple paying 24% of its FCF at present to make dividend payments, the big room to expand the payment is likely going to have to come from increased cash flows in the future. Unless, of course, Apple breaks the tech mold and is comfortable with, say, a 40% FCF payout.
Now, if Apple chooses to do the popular thing among large tech dividend payers and offer investors 30% to 35% of its FCF as dividend payments, we are looking at a range of $13.4 billion to $15.6 billion per year. At the current share count of 938.6 million, you are looking at a potential payout of $14.28 to $16.62 per share annually. At the current price of $524, that would be good for a projected yield between 2.7% to 3.2% versus the current 2.27% yield. In other words, under this scenario, which I believe is most likely, Apple holders have something like 50 to 100 basis points in potential yield expansion based on Apple simply catching up with its contemporaries in terms of FCF coverage on its dividend payments. That is a worthy increase but not gangbusters.
In a more unlikely scenario, Apple could break the tech mold and go more towards 50% of its FCF in terms of dividend payouts. While this would be a very long term goal, it is possible that Apple may get there at some point. However, I don't think this is within even a medium term time frame. But just for giggles, if Apple were to pay out dividends at the rate the consumer companies I cited above do, it would be able to pay $22.3 billion annually in dividends, or $23.76 per share, good for a whopping 4.5% yield.
Again, I don't think this is realistic to expect given Apple's conservative nature, the fact that it just began paying dividends (again) just over a year ago and the fact that its business requires an enormous amount of R&D. However, if Apple ever gets to be a mature tech company like Microsoft, IBM or others and no longer needs huge R&D budgets and offshore cash piles, perhaps the payout will inch its way towards 50% of FCF. However, I'd expect we won't see higher than 35% simply because market participants aren't demanding it. Apple is keeping up with the Joneses in terms of its FCF payout and isn't required to do more. With market participants fat and happy with Apple's current dividend, incremental payout increases are all you're likely to see. The bottom line is Apple could significantly increase its payout ... but I don't think it will.