Apple's Dividend At $20 In 5 Years? Not Gonna Happen

Mar.31.14 | About: Apple Inc. (AAPL)

Summary

Apple simply doesn't earn enough to buyback nearly $13 billion per year in shares and pay a $20 per share dividend.

Even if it did earn that much, the 3.7% yield on cost isn't enough to justify waiting five years as you can do better.

Share-based compensation means aggressive buyback targets are that much harder to reach.

Last week, Timothy M. David McAleenan Jr. wrote an article about Apple's (NASDAQ:AAPL) dividend hitting $20 within the next five years from the current $12.20 payout. In it, he postulates that Apple's robust buyback program and earnings growth, combined with an increasing payout ratio will drive the dividend up roughly 75% from where it is today and thus, make the stock a buy based on dividend growth. I find this argument to be a bit short-sighted and in this article, we'll take a look at why I respectfully disagree with Mr. McAleenan's method and conclusion for how this makes Apple shares a buy.

The central tenant of the author's position is that Apple is buying back 4% of its shares each year and that this will allow the company to reduce its share count to 775 million within five years. At the current 892 million level Apple has outstanding, the author is counting on a reduction of 13.1% of shares in the next five years. While this is not an unrealistic expectation for many companies, let's examine what this implies for Apple. At today's price of $540 per share, retiring 117 million shares in the next five years means Apple will need to generate $63.2 billion, or over $12.6 billion per year, simply to buy back shares. This also assumes that Apple's share price never rises, making this program even more expensive in the event that it does.

Apple is expected to earn ~$41 billion next year but it is important to understand that ever since Cook took over, earnings estimates have been too high for Apple to reach. Regardless, if we assume that $41 billion is the right number, Apple will need to not only pay out $11 billion in dividends, assuming no dividend increase this year or next, but it will also need $12.6 billion to buy back shares in order to keep pace with the author's goal. That means that Apple will be paying out right at $24 billion per year in buybacks and dividends, making it perhaps the most aggressive returner of capital in history.

I'm not saying this isn't possible (although it is very unlikely) but what I am saying is that even if Apple can spare $24 billion each year, it isn't enough. Apple, like virtually any other public company, compensates its employees with stock. Apple issues millions of options and shares each year meaning that a decent portion of that buyback will simply counter the dilution that compensation is causing. I have no problem with Apple paying its employees with shares but it makes an ambitious share reduction goal much more difficult to achieve because you must first mop up the additional shares before any real reductions can occur. I feel as though the author's analysis fails to address this fact.

Mr. McAleenan also contends that Apple needs $10.5 billion in annual profits to continue to run its business. I have no idea where this number came from as it isn't explained, but as Apple's products, sales and margins have stagnated or declined, that number, whatever it is, is likely set to rise in the coming years. Technology companies like Apple, and especially ones that sell products instead of software and services, must continuously spend enormous amounts of money in order to stay relevant. If you don't believe me, just ask Intel (NASDAQ:INTC) shareholders. Apple will need to spend aggressively on R&D in the coming years in order to simply try and stay relevant. This means that this $10.5 billion, wherever it came from, will likely rise in the future as profits are stagnating and declining, meaning the ability of Apple to return $24 billion per year to shareholders will be greatly reduced. If Apple were a software seller, meaning it had annuity-type revenue streams, it wouldn't need to spend so aggressively but since it must continue to sell products one at a time every single day, it is at a disadvantage to an IBM (NYSE:IBM) or Oracle (NYSE:ORCL).

Finally, I would ask, even if Apple's dividend gets to $20 in five years, so what? That would mean that yield on today's cost would still only be 3.7% and that assumes that $20 in dividends actually happens. If you are looking for a dividend stock, there are countless names that already yield that much and/or are growing their respective dividends more quickly. In the mega-cap technology space alone you can look at Cisco (NASDAQ:CSCO) and Intel as examples of companies with higher yields than Apple. While those companies have their own challenges as well, you aren't going to have to wait five years for them to yield 3.7%.

The bottom line is that the author's math is a little fuzzy to me and even if we assume he is 100% correct with all of his assumptions, a $20 dividend is certainly no reason to buy Apple. If you are simply holding on for a dividend you can do much better today without even looking outside the mega-cap technology space. If you are more open to different industries there are dividend aristocrats everywhere with much better long-term prospects than a simple smart phone designer. In order to make Apple a buy simply because of the dividend you need to be talking in the $30 range in five years, a number which simply isn't possible.

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.