With the recent first quarter earnings results leaving many analysts a bit frosty towards Apple (NASDAQ:AAPL), many investors are rightfully concluding that Apple's growth glory days are behind it. They predict slower growth and see Tim Cook's acquiescence to a larger share buyback and dividend as an admission that Apple has gone from Google (NASDAQ:GOOG) to Microsoft (NASDAQ:MSFT), from hot and sexy growth story to boring dividend payer. I'm here to both agree with that characterization and to argue that this is not cause for wailing and gnashing of teeth but celebration. Yes, Apple is set to become like Microsoft, and that is a great thing.
First, let's take a look at the things that investors hate about Microsoft. For those who bought MSFT at its Nasdaq Bubble peak, they are only now breaking even, due to dividend payments.
This was because MSFT started out the decade at the top of the Nasdaq bubble outrageously overpriced.
while Apple, trading at 12.5x earnings, is not. In fact, Apple's current PE of 12.5 is nearly 40% lower than those of companies that are growing half as fast as Apple, such as Kimberly-Clark, (NYSE:KMB) Johnson & Johnson, (NYSE:JNJ) and Coca-Cola (NYSE:KO), which have PEs of 19, 18 and 19 respectively. Microsoft and Intel (NASDAQ:INTC), two former high flying tech companies now turned slow growth dividend payers, have PEs of 13.4 and 12.7 respectively, both at the level of Apple's. In this article, I will both point out why Apple's PE deserves to be higher than the above mentioned dividend champions. However, if it remains as low as it is, Apple will still deliver market beating returns, as I'll soon show.
Many have compared Tim Cook to Steve Ballmer, Microsoft's CEO post Bill Gates, who was nearly universally panned as a uncharismatic, sometimes silly, technocrat. Many said he didn't have an iota of true passion in his body and who's main strength was in running operations smoothly and lighting money on fire with foolish acquisitions. In fairness to Mr. Ballmer, Microsoft's operating performance under him was very good, as a quick look at historical EPS will show, 10.4% annualized growth in EPS over 13 years.
Today, Tim Cook is seen as the same way, noncharismatic technocrat, master of supply chains and operations but unable to launch new, sexy products, (though thankfully he doesn't believe in large, foolish acquisitions). People fear that Mr. Cook, like Mr. Ballmer will squander the legacy he's been given and just milk Apple's cash cows without any new innovation. Just as Microsoft's main cash cows, Windows and Office are seen as boring, many say that the iPhone and iPad are becoming stale and without new products, sales of both will go into a PC like decline, dragging Apple's stock down with it.
I'd like to make two arguments; the first new, better products are coming, but also that two, Apple doesn't need new worlds to conquer in order to deliver great returns. In fact, though it may seem like heresy to some, I'd like to argue that if Apple fails to deliver new products that it will become the new Microsoft, (which is a good thing) but if it does deliver new products, it will become the new Kimberly-Clark, (which as I'll show, is a great thing).
First new products: The expected iWatch is likely to do for smart watches what the iPod did for MP3 players and what the iPhone did for smart phones, which is to arrive fashionably late and set the standard that everyone will try to copy later.
In fact, it seems like the biggest feature of the iWatch will be health and vitals tracking, perhaps even monitoring and automatically recording blood sugars.
For a nation that is suffering from an obesity and diabetes epidemic, such a feature might have nearly every doctor in the country asking patients to wear such a device and insurance companies might start paying for them. These kinds of subsidies could lead to hundreds of millions in annual sales globally and extra tens of billions in added profit to Apple's bottom line, allowing the stock to easily double from its current prices.
Next is the long rumored Apple TV, which is being held up by negotiations with television program providers and cable companies. I am confident that just as Tim Cook was able to get all the recording companies onboard with iTunes radio, so too will he eventually launch iTV and sell tens of millions of premium smart TVs, though it may take an additional year or two to reach the market.
Finally, with their arch nemesis Samsung announcing that it's doubling down on "big, bigger, biggest" and considering launching megatablets ranging in size from 12-20", 2014-15 may see Apple compete with Samsung in the megatablet space with the 12.9" iPad Pro.
But even if Apple doesn't release any new products in the next year or two I believe it will still deliver market beating, 15-18% annualized results and here's why:
1. Cash flow machine: $44 billion in free cash in the last year. In fact, 26% of Apple revenues get converted into free cash flow. Apple's revenues are expected to grow at 5-6% annually over the next 5 years, (assuming no new products are released).
2. Giant hoards of cash that sit at $159 billion and grows at over $40 billion/year that will fund future buybacks and dividend increases.
3. Dividend and share buyback: In just 3 quarters Apple's share count has declined by 50 million shares, or 6%. And just today, Tim Cook announced that Apple bought back $14 billion of its shares in the last 2 weeks. This was in response to the 8% haircut that occurred after the recent earnings announcement and represents 3% of the outstanding shares. This will enrich all long term shareholders because it gives each share a larger slice of Apple's enormous profit pie.
4. Historically, dividend champions share prices grow at the rate of their dividend. In this case Apple is not yet a dividend champion, (25+ years of consecutive dividend increases) but it has the makings of one and the first dividend increase of 15% indicates that Tim Cook and the board are serious about shareholder friendly actions.
5. Tim Cook has a major incentive to see the dividend rise sharply: lets not forget that from in 2016 and 2021 Tim Cook will receive 500,000 shares each, for a total of 1 million shares. Tim Cook's salary is $4.25 million. If the dividend were to grow at 15% until 2021 then Tim Cook's dividend haul would be $32 million/year, or nearly 8X his current pay.
6. Historically dividend growth stocks return yield+dividend growth rate: Which I believe will be 15% dividend growth over the next 10 years plus the yield that means a 17.5% annualized rate of return. Market spanking to be sure and that's assuming that Apple's valuation remains remarkably low. This situation would require no new product launches.
7. Apple is growing slower but still growing: iPhone 6 will bring a new form factor with a larger screen which will help iPhone immensely in the Chinese markets that the recent China Mobile deal opens up. Meanwhile, large phones are becoming a favorite in Asia and so an iPhablet could break off a piece of that profit pie for Apple. Meanwhile, Mac sales are at all time highs as are iPads and iPhones, weakening the argument that Apple's existing products are in decline.
Apple may be done with its hyper growth of yore but growing like MSFT; 5-10% annually is still likely, because it still has a loyal following that enjoys its products.
8. Smart Phone market is maturing and stabilizing:
Smart phone sales are slowing as developing markets saturate, but this year more than 1.5 billion phones will be sold, and that number 2.5 billion+ by 2020. Even if apple's global market share falls to 10%, (and I would argue that larger screen phones and an iPhablet should stabilize market share at 12.5% or even raise it as high as 15% long term) that's still 250-375 million iPhones/year, 100-225 million more than today. That means a doubling of earnings, solid revenue growth and an even larger cash flow tsunami that will keep the share buy backs and dividend growth (and with it the share price appreciation) humming along nicely.
9. Competition is running out of room to out maneuver Apple:
I am not an Apple fanboy; I have owned both iPhones and Samsungs and Motorolas, but the idea that Apple is going to be left in the dust by competitors I believe to be backwards.
The fact is that all smart phones are reaching a point of "good enough" hardware, the point of diminishing marginal returns that will make consumers focus on the overall user experience, which has always been an Apple strong point.
Within 5 years, phones hardware specs will reach a point where competitors won't be able to crush Apple. Who cares if your phone has 256 gigs of storage, a 55 MP camera and a 64 bit octacore processor running 8 gigs of ram, if the iPhone with its superior user interface lets you do what you want with 1/5 of the hardware in a smaller, lighter, more elegant package?
10. Other "boring dividend growth" companies return amazing performance, even those growing slower than Apple. Both Kimberly-Clark and Microsoft have done very well, returning 20.4% and 16.7% when dividends are included and reinvested. Both companies have growth rates about half to a third of Apple's and likely to continue to grow at for reasons listed above.
So why has Apple's stock price stagnated recently? If dividend growth investors make the above companies such winners, why isn't Apple roaring along as fast as, if not faster than them? Why is their valuation stuck at 12.5X earnings and not 19 like slow growing and boring dividend favorite, Kimberly Clark?
I believe the reason is that Apple is so new to the dividend game. Many dividend investors and funds wait to see a consistent history of annual dividend increases, sometimes as much as 10-25 years (the so called "dividend achievers and champions"). Once Apple has 5-10 years of solid, consistent dividend growth under its belt than the stock will start rebounding to its new, dividend growth valuation, which should see its PE rise to something more akin to Kimberly-Clark's 18-21. This is what I meant when I said that it would be good for Apple to become the next MSFT, (low PE, no new products) since dividend growth will return 17.5% or so annual returns. However if Apple releases new products and achieves a Kimberly-Clark like valuation, then its performance will truly become stellar. How good would it be? Let's take a look.
Assuming that the recent 8% earnings growth continues for 5 years, and the above valuation expansion and taking into account the $106.80 in expected dividends through 2018, one gets a 5 year price target of $1,238 to $1,321. This represents 19-21% annualized returns. Note that if you reinvest your dividends then your total return is bumped to 20-22%, achieving truly fantastic Kimberly-Clark like returns, (remember KMB returned 20% annually over the last 5 years). Of course if Apple's future products prove as amazing as I mentioned earlier, (iWatch as daily health monitor) then those numbers will prove to be conservative.
Meanwhile, technical analysis shows Apple is very undersold, with RSI around 25 and MACD indicating negative momentum has peaked. Slow stochastics show Apple poised for a rebound off of these low levels, and as I have just shown above, Apple remains a fundamentally sound company with many years of market smashing returns ahead of it. At current prices near $500/share, Apple remains an outstanding candidate for a spot in anyone's dividend portfolio as long as you have a few years and patience to let the thesis play itself out. I am very confident that you won't be disappointed with the results. For all the reasons stated above, I am placing a 5 year price target for Apple at $1250/share.
In summary, yes maybe Apple is becoming like Microsoft or even Kimberly-Clark, a boring slow growth dividend payer. Maybe Tim Cook doesn't have the same charisma in his entire body that Steve Jobs had in his pinky, but the man knows how to keep the house that Jobs built humming and cranking out excellent products that people will continue to enjoy as surely as people will keep buying smart phones and toilet paper. That will keep the cash flow going, which will allow the dividend and decreasing share count to drive the share price up by a market trouncing amount of approximately 17.5-22% over the next 5-10 years, and that ladies and gentleman is the bottom line.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.