By July of this year, Apple (AAPL) will officially be a dividend stock. This development is no surprise for the market. Even though many of Apple's most zealous fans have continued to hold out against the possibility of a dividend, even in the face of mounting evidence to the contrary, anyone who's been paying attention has seen the signs coming a long time ago. What may have actually taken investors off-guard is that Apple's dividend is so conservative: at $2.65/share per quarter, that's only a yield of 1.8%, well below consensus estimates of 2-3%. All in all, it was a rather anticlimactic announcement given the enormous amount of build up in the recent months, culminating in a two month run of over 40% in the stock price.
However, I would argue that such a small, conservative step is to be expected from Apple's management. CEO Tim Cook has always been a patient man, and anyone who has heard him speak has witnessed the slow, methodical way that he thinks and communicates. Furthermore, it's in Apple's DNA to move slowly and carefully, and do things right instead of fast. It's one of the qualities that has allowed it to achieve the success it has today, and there's no reason for the company to abandon that trait when it comes to managing its finances.
By initiating a dividend, Apple has officially acknowledged that it recognizes the necessity of unlocking shareholder value by returning excess cash to owners rather than letting it sit on the balance sheet earning 0.77%. As an Apple shareholder, that's all I really needed to see. Even though Apple's effective payout ratio at its current distribution amount is relatively low, I fully expect that number to increase significantly in the years to come. A study of other dividend-paying technology titans will confirm an identical pattern, where they start off with a low payout ratio and continue to raise it in excess of earnings growth in the ensuing years.
- Microsoft (MSFT) initiated its first dividend in 2003, paying $0.08 on diluted EPS of $0.92 for a payout ratio of 8%. As of the last fiscal year, this dividend has since grown to $0.61 on $2.69, a payout ratio of 22%.
- Intel (INTC) has a much longer dividend history, but it didn't begin to seriously commit to its dividend until 2004, where it doubled the previous year's payout of $0.08 to $0.16 on $1.16/share of earnings for a payout ratio of 13%. Intel's dividend has since grown to $0.78 on $2.39 for a ratio of 32% and a current market yield of 3%.
- Cisco (CSCO) didn't even begin paying a dividend until last year, when it initiated a $0.24 per share dividend on diluted earnings of $1.31, representing a payout ratio of 18%. It has already hiked its dividend by 33% to $0.32/share annualized.
Apple's starting payout ratio is already larger than those of all three companies when they first began distributions, and there's nowhere for it to go but up. One of the biggest advantages of Apple's business model is that it is not capital intensive, and significant growth can be achieved with minimal capital injections. That means that as long as the company continues to execute on the same level it always has, shareholders can enjoy large gains in market value and a beefy dividend to boot.
Considering that the stock went up over 3% in the pre-market and dropped into the red right after the conference call, it's obvious that many shareholders are disappointed by Apple's seemingly paltry dividend, including some of my fellow SA contributors. Don't be. Long term owners can expect to see a much larger income stream in their future than today's announcement would imply, either through a rapidly growing baseline payout ratio, significant share repurchases, or a series of large special dividends. Not only is this trend supported by the historical financials of other companies in the industry, it also fits Apple's corporate culture to a T.
The market should be ready: Apple is now an income play. It's no coincidence that as of this writing, Apple is up over 1% while all three stocks mentioned above are in the red. Up until now, income investors who wanted exposure to the technology sector have been forced to choose from second-rate companies like Microsoft and Cisco. Now that Apple has entered the game, this is no longer true. In the days to come, I expect a significant outflow of funds from other dividend-paying technology companies and into Apple, as dividend investors and income-oriented funds now have a much more lucrative parking space for their money.
If you're a Microsoft investor and you're in it for the dividend, buy Apple. If you're a Cisco investor and you're in it for the dividend, buy Apple. If you're an Apple investor, hold. Tim Cook is a very smart man who understands that cash that is not deployed is a depreciating asset that will eventually be consumed by inflation. 1.8% may not seem very high, but this is just the beginning. The best is yet to come.