## Basics of the research

This article presents a risk and reward research on the Apple (NASDAQ:AAPL) stock. It is inspired by a recent series of articles on the risk and reward characteristics of five dividend paying stocks - Johnson & Johnson (NYSE:JNJ), Coca Cola Co. (NYSE:KO), Procter & Gamble Co. (NYSE:PG), Chevron Corp. (NYSE:CVX) and PepsiCo, Inc. (NYSE:PEP).

Apple still has a long way to go before it could get closer to those dividend giants. Our point here is to test how long this road could be given that the company decides to take it.

Because the company has a fairly long trading history, we also examine the historical risk characteristics of Apple's stock and focus especially on the tail risk. **Tail risk** is the risk of getting returns which stand as far as several standard deviations from the mean. By definition, such tail returns are a rare event. The tail risk is represented by two characteristics of the distribution of returns - skewness and kurtosis.

## Skewness

Regarding the long-run risk of loss, a *positive skewness* is sometimes the preferred one. The reasoning behind this view is that a positive skewness incorporates a higher historical probability that a large unexpected return would be on the positive side, i.e. larger than the mean. On the other hand, a negative skewness presents a higher probability of an unexpectedly large negative return during some period. Hence, it shows an increased risk concerning the available capital at the end. For a better understanding the reader could use the classic explanation where the negative skewness is compared to picking up nickels in front of a bulldozer. The large unexpected negative return comes with the bulldozer's move.

## Kurtosis

The *kurtosis* as a measure of risk indicates whether the return distribution experiences *fat tails*. Those are major risk descriptors which show whether there is a larger than the normal probability of having returns far from the mean, both positive and negative. For instance, a kurtosis value of zero shows there is no such higher-than-normal probability. We should note that by 'normal' we mean the probability presented in a normal distribution of returns and not the returns of some particular benchmark index.

For more information, readers could check the Johnson & Johnson article in which the skewness and kurtosis were explained in more details.

The total return of a stock is a sum of its price change and the cash flow which investors get on a regular basis, basically in the form of dividends. Because dividends and share repurchases are a major part of the examined stocks' total return, a special attention will be paid to risk on cash distributions.

As with the other examined companies, this long period (30 years in the case of Apple) includes several different economic environments and cycles, both good and bad ones. Hence, the calculated long-run coefficients could be expected to be relatively free from sampling biases and closer to the true descriptors of the stock's population of returns.

Nevertheless, the readers should keep in mind that *historical performance does not guarantee future results*.

Readers should also account for the *mean reversion tendency* the returns generally exhibit in time. As mentioned in the first article, the performance in the more recent periods, i.e. the last 12 months or last 5 years, could be more important and useful for the moment but it would tend to get closer to the mean characteristics of the longer time frame periods, *given that no significant change in the economic environment or the company itself has happened*.

## The Other Companies Selected

The other companies selected for comparison purposes have a long dividend distributing history. Moreover, they have increased the dividend size in almost each of the last 40 years.

The average yearly dividend increase for them is as follows:

During the last 5 years the companies also distributed wealth to their shareholders through share repurchases. Generally this increases the demand for stocks and has a positive effect on their price. If at the end of the fiscal year the company has a different amount of basic shares outstanding than at the beginning, this change could also affect the size of the dividend paid and the payout ratio.

## Apple Stock's Characteristics and Analysis

Some considerations about the dividend estimates in Table 2 above follow.

We should keep in mind that the fiscal year for Apple is October - September. Hence, its financial reports for the last two years include dividends payments of two different sizes - one from the beginning of the capital return program ($2.65 quarterly) and one after its change ($3.05 quarterly). With overall of $100B to be returned to shareholders till the end of 2015 we have about $40B at most to be distributed as dividends. This is because the management authorized the use of $60B for share repurchases. For simplicity we do not include the money that will be used to net-share-settle vesting restricted stock units which are about $3B. We also accept that the money for repurchases will be used fully.

The company has used about $13B for dividends till now. So there are almost $27B left till the end of 2015. Split it by two and we have about $13.5B for each of the two years left. With two of the quarterly dividends of Apple's current fiscal year already dispersed we could estimate that there are about $7.9B left at most to be distributed during this fiscal year. Split it by the average number of shares outstanding for the last 5 years and we arrive at $4.29 quarterly dividend for the next two remaining quarters of the Apple's fiscal year. Multiplied by four it gives us a possible higher boundary of the range of $17.16. This implies another increase of the dividend of 40%. This would mean almost $4B more distributed in dividends for this year which would increase the payout ratio of the company close to 38% given its current financial results. Such a payout ratio is not so high in the world of dividend paying companies but it could put some pressure on Apple's financial results having in mind the current company's cash distribution ratio (shown at a later point in the article to be 90%).

The above considerations however imply that given the current conditions of the capital return program there will be no other increase of the dividend. This seems highly improbable to us in a world of struggling "worse-than-expected" and "better-than-expected" news about companies. Thus we could conclude that there should be another increase expected in the second half of the two remaining years of the program. Hence if we use a payout ratio of 30% which is close to the last year one, and a projected net income available to common for the fiscal 2014 of $44B, after calculations similar to the ones above we arrive at the lower boundary of our dividend range of $3.80 quarterly dividend (or $15.2 on annual basis). Here the implied increase is almost 25%. This will give the company a space for another increase in the second of the two years remaining till the end of the program.

The readers could check the article of Chuck Jones about another perspective on the lower boundary of next dividends of Apple.

## Comparison with Johnson & Johnson, Coca Cola, Procter & Gamble, Chevron and S&P500

The Compound Annual Growth Rate based ranking between several dividend paying companies and Apple goes like this:

We see that Apple provided the *best compound annual growth rate* for the examined period in the group. It also provided the best return for the last five years. This is not unusual because despite its fairly long history the behavior of its stock followed more closely that of a developing company than that of a mature one. This is proven by the data on its risk adjusted returns.

## Risk Adjusted Returns

Regarding the risk adjusted price return for the whole examined period, the AAPL stock presents itself as significantly more volatile than the others in the group (JNJ, KO, PG, CVX) and S&P500. The Sharpe ratio shows Apple's stock as being in the middle of the range while the standard deviation puts it as the most risky stock in the group. As history shows standard deviation captures risk for both positive and negative returns.

## Price Trend

Looking at the graph of adjusted monthly prices we see a steady uptrend (the green line). It is interesting to note that AAPL's extensive growth in price started in 2004 with the internationalization of its iPod business and the opening of international Apple stores. What drives the stock price clearly seems to be the innovation the company provides. Which logically rises the question what the price would do if the pace of innovations slows down.

The current capital return program gives a possible answer - the management in place might be willing to accept a bit of a slowing in the innovation process in exchange of a more stability in the development of the company. The answer if this is the case would depend on whether the Apple's dividend policy is continued.

What history shows us is that there has been a major change in the character of the company - it grew from a pure computer producer to a consumer company which supplies various human needs. Thus we could conclude that despite the long history of trading, the company's population of monthly returns might be still in its developing stage. This explains also the volatility we witnessed in the stock's price during the last year.

During the last major decline of the U.S. equity indexes in January 2008 - January 2009 AAPL lost about 54% while S&P500 was down by 44%. This is normal having in mind the large beta (1.32) the Apple stock experiences towards the S&P500.

Apple undertook 3 stock splits in the examined period - in June 1987, June 2000, February 2005. The prices at which the stock experienced a split were between $80 and $103.

## Analysis of Risk on Dividends and Cash Distributions

Apple started as a dividend paying company almost 30 years ago and then suspended paying dividends until recently. Among the main reasons for this was the exponential growth the company experienced in its operations. The management body must have decided that putting cash back in operations is more needed and would be preferred by investors.

The announced in the middle of 2012 capital return program aims at returning $100B to investors by dividends, share repurchases and other options by the end of 2015. The company also plans to borrow instead of just using inside generated cash which to return to investors. Given the current low interest rate environment this could be a reasonable step but it will increase the debt burden on the company's financial results. Moreover, such a strategy implies that Apple will be able to continue to gain cash at excessive levels which in a competitive environment might be an uncertain event.

The main point of worry with this program as long as it concerns the steady flow of dividends is that *it has an end term*. After that term the management might decide that it is again better to use cash in operations than to return it to investors in the form of dividends. This presents a major difference between Apple and the other big dividend players. This feature might prevent the company from being included instantaneously in dividend return portfolios until there is more information (and history) on the long term prospects in front of Apple's dividends.

The payout ratio of AAPL is among the lowest one in the examined group of companies, close only to that of Chevron. The cash distribution ratio however, which includes dividends and share repurchases, puts Apple near the top of the list. All other things equal, these present Apple as a company with a *normal to high* level of risk concerning the cash distribution to shareholders compared to the other examined companies. Still those characteristics should not be used in isolation because by distributing this much cash to its shareholders, the company effectively lowers the price risk of its stock. A potential problem could arise in a situation of an increasing cash distribution ratio and a lower net income.

## Other risk characteristics

Monthly coefficients:

Examining the whole period of 30 years we see a returns distribution with a slightly **negative skewness** and a significant excess kurtosis. The negative skewness (-0.15) speaks of a higher-than-normal historical risk of an unexpected negative monthly return which would stand far from the mean value. Of the examined stocks and S&P500, only CVX has a noticeable positive skewness. All the others exhibit a negative (KO, PG, SPX) or close to zero skewness. AAPL's skewness puts the stock in line with KO regarding this characteristic.

It is important to note that if we do not count the major decline of almost 58% during September 2000 when Apple was still only a computer producer, the *skewness of the company becomes positive* (0.08) which would imply that historically most of the unexpected results far from the mean would be greater than the mean.

The kurtosis (1.14) is the *second lowest* in the group. Only JNJ has a lower kurtosis for the whole examined period. Such a kurtosis shows a distribution with **fatter tails** compared to the normal one but not so fat as those of the other remaining four companies and S&P500. The fatter tails present an increased probability of having extremely large returns on both sides of the mean, generally. Having a distribution with slimmer tails than most of the other examined companies implies that Apple's monthly returns would be more condensed around the mean.

Only the 12 months period changes the skewness to a significantly negative one which shows increased probability of having large unexpected returns which would be lower than the mean.

Because of the mean reversion tendency which the characteristics of the returns generally follow, we could expect that the more recent descriptors would converge to the longer term ones. If the long-run coefficients are indeed closer to the true population descriptors, we should expect the recent risk characteristics of AAPL to gradually revert to the longer-run values. In the case of AAPL this could benefit the stock's risk characteristics regarding the skewness by reducing the probability of having large extreme returns below the mean.

Chebishev's confidence interval shows that with the current monthly returns distribution values in 75% of the time we could expect that the monthly return of AAPL would be between -24.32% and 29.13%.

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