Putting Apple's Dividend Into Perspective

Apr.30.14 | About: Apple Inc. (AAPL)

Summary

Apple has announced an expansion of its capital return program.

Apple’s dividend remains small relative to free cash flow.

Apple’s valuation remains cheap relative to other mega caps.

Last week, Apple (NASDAQ:AAPL) made waves with impressive quarterly results. The market responded enthusiastically, sending AAPL shares up over 8% on Thursday.

Here are some of the highlights from the report:

  • Apple bested consensus earnings estimates by 14%, which is its largest EPS surprise since its 23% beat in Q2 2012.
  • Revenue totaled $45.6 billion, ahead of consensus estimates and the highest for a non-holiday quarter in the company's history.
  • Apple's Board of Directors authorized an increase of its capital return program to over $130 billion, including a $90 billion share repurchase program - up from $60 billion.
  • An approximate 8% increase in Apple's dividend was authorized. This compares to a 15% increase in 2013.
  • A 7-for-1 stock split was announced.

Although the stock split doesn't have any economic impact whatsoever, Apple will now likely become a member of the prominent Dow Jones Industrial Average.

Now, analysts are making a pretty big deal about the fact that Apple has become the world's biggest dividend stock (although, I think Quartz used a stale shares outstanding number in their calculation). The new annualized dividend amount will be somewhat less than $11.34 billion, depending on the buyback program's purchases.

But remember, a dividend should be looked at in relative terms. And, as we know, Apple is a massive company. So even with its dividend hike, it still has a lower yield than the four other largest U.S. companies that pay dividends.

Not to mention that Exxon Mobil (NYSE:XOM) should be raising its dividend for 2014 any day now. Fellow technology company Microsoft (NASDAQ:MSFT), and industrial conglomerate General Electric (NYSE:GE), are rapidly growing their dividends as well.

At the same time, though, Apple does have the most aggressive share buyback program. Johnson & Johnson (NYSE:JNJ), on the other hand, is actually issuing shares and diluting shareholders! This makes JNJ's dividend much less appealing, an observation I've talked about in the past with utilities.

Going forward, Apple has made an explicit commitment to "increase its dividend on an annual basis."

It has plenty of room to do so, too. Just take a look at the following chart, which shows the size of Apple's dividend relative to its free cash flow (operating cash flow minus capital expenditures).

The dividend growth commitment is a very positive development for shareholders, and we've certainly been bullish on Apple's stock this year.

Better yet, the stock is still cheap. The table below compares Apple's valuation metrics to those of the average mega-cap dividend payer (i.e., companies with equity market capitalizations greater than $100 billion).

Now, the price-to-earnings (P/E) ratio is a flawed metric when assessing AAPL's valuation, since the company's revenue and earnings are growing so much faster than the average mega cap.

But by looking at the PEG ratio - which compares the P/E ratio to the estimated earnings growth - AAPL simply blows away the competition.

There are also ways to value Apple and adjust for its massive cash pile, which stood at $150.6 billion as of the end of March 2014 (88% of that cash held offshore).

For example, enterprise value includes equity market cap plus debt (also preferred stock and minority interest, if any). But it reduces this total stakeholder value by the amount of cash on the balance sheet.

And as you can see in the table, Apple's free cash flow yield of 13% shows that it is, indeed, a cash flow juggernaut with an overall cheap valuation.

Bottom line: Apple is inexpensive by almost any valuation metric, and it's set to become a prolific dividend growth stock. This makes it one of the most attractive mega caps for income investors.

But there's more to the story.

Apple is going to raise debt as it did in 2013 to help fund its share buyback. This is partly so that it doesn't have to repatriate (bring home) cash held abroad, which would incur a significant tax liability.

However, there's something bigger going on here…

Apple isn't alone in its push to become more highly levered. I mean, issuing debt in order to make acquisitions, buy back stock or pay dividends is all the rage right now.

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. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Dividends & Income Daily is a team of financial researchers. This article was written by our Editor-in-Chief, Alan Gula, CFA. We did not receive compensation for this article, and we have no business relationship with any company whose stock is mentioned in this article.