On March 19, 2012, Apple (AAPL) announced plans to begin paying dividends for the first time since 1995. According to the release, Apple (AAPL) will pay out a $2.65 per share quarterly dividend during the "fourth quarter of its fiscal 2012, which begins on July 1." Apple, of course, has developed a cult following as the stock has taken a helicopter lift from $100 to $560 over the past three years. During this period, the faction of tech geek hipster Apple fan boys has spread to include owners of stock who lustily applaud every move that management makes. I today, represent Ebenezer Scrooge, and the voice of reason. I refuse to shill for dividend payments from any corporation allegedly in growth mode.
The Growth Story
Over the past three years, Apple is averaging 75-percent increases in net income growth. In its latest annual report, the company's 41-percent tallies in both gross margin and return on equity prove that Apple products still carry obscene pricing power. Apple now operates beneath the halo effect, where the quality of every product unit sold reinforces bolt-on sales into a closed iPhone / Macbook / iPad ecosystem. The corporation has caught lightening in a bottle - where customers will happily pay up to remain part of the "in crowd." By all current measures, Apple remains firmly entrenched within growth mode.
As with any corporation, Apple must make the call whether to either reinvest earnings back into its business, or to return profits back to investors, in the form of cash dividends. Dividend payments, of course, are not tax-deductible items for corporations.
In its latest quarterly report, published on April 25, 2012, Apple posted $39.2 billion in net sales and $11.6 billion in net income - to cover 933.6 million shares outstanding (933.6 million shares used in computing basic earnings per share). In a weaker quarter, Apple is operating with a 30-percent net margin ($11.6 billion net income / $39.2 billion net sales). With the proposed $2.65 / per share quarterly dividend, Apple would be making $2.5 billion in quarterly dividend payments, or $10 billion annually, before the inevitable dividend increase. At 30-percent net margins, these dividend payments could have been reinvested back into the business - for an additional $3 billion in net income, or $3.21 earnings per share.
Instead, investors are jumping for joy over a $2.65 quarterly, or $10.60 annual dividend. If Apple were to simply stand pat, it is likely that we would all be at least a nominal $3.21 ($10.60 cash left on Apple's books + $3.21 earnings) per share wealthier after one year. Theoretically, $3.21 in perpetual earnings would add $46 to Apple's share price, if capitalized at 7-percent ($3.21 / .07 = $45.86).
Dividend income, of course, will trigger tax consequences for investors. For 2012 tax purposes, dividends are either classified as ordinary or qualified. Ordinary dividends are taxed as ordinary income, where tax rates reach as high as 35 percent. Alternatively, qualified dividends are either tax-free or taxed at 15-percent rates. For qualified dividends, you must hold Apple stock for more than 60 days during the 121-day period surrounding the company's ex-dividend date. Be advised that qualified dividend tax breaks are set to expire into 2013, when the top-line tax bracket shifts up to 39.6 percent.
By all measures, it makes no economic sense for a rapidly expanding corporation to pay out dividends. For dividends, I would rather buy and hold Altria (MO), while also funneling cash into a pure play zero-growth utility stock.
Maybe Apple executives, with their recent dividend and share buy back proposals, know some things that we do not.
Mutual Funds and Retail Investors
Growth and income equity mutual funds that manage several hundreds of billions of dollars will feed at the trough, after Apple initiates dividend payments. Fund managers who are mandated to purchase dividend-paying stocks will lustily eye Apple shares as core holdings. Also, as part of their respective prospectuses, many of these funds must remain effectively fully invested within the market. Volatility will only increase, as more mutual funds stampede into Apple's shareholder mix. Inevitably, Money flows will highlight a train wreck of fund managers jamming cash into Apple shares at the top; and liquidating positions at the bottom to meet fund redemptions from nervous retail investors.
I would argue that increased mutual fund involvement mimics a stock split, in terms of the composition of Apple's shareholder base. A study by Dan French and David Dubofsky for The Journal of Portfolio Management reveals that stock splits exacerbate price volatility when smaller, less sophisticated investors hop aboard and start trading.
Volatility is only a "good" thing for options strategists, speculators, and short-term traders. Prospective long-term Apple investors, however, should reject dividends and any other proposal that accommodates a sheep-like mentality within our shareholder base. At worst, a missed earnings report could precipitate a flurry of automatic program trades to Flash Crash the stock, at the very moment you wish to cash out and spend your Apple proceeds on a Pacific Coast Highway retirement home.
The Bottom Line
On May 24, 2012, Apple shares closed out the trading session at $560 (1.9 percent dividend yield for $10.60 annual dividends). Shares are now valued at 14 times trailing earnings, which compares favorably to Coca Cola (KO) (20x earnings), Altria (19x earnings), and Procter and Gamble (PG) (19x earnings). At these levels, Wall Street considers Apple's rapidly growing earnings power to be worth less than our stodgy soft drink, tobacco, and toilet paper empires.
Aside from future earnings expectations, Apple carries $10.1 billion in cash, $18.4 billion in short-term investments, and $81.6 billion in long-term marketable securities, over top of 929.3 million shares outstanding. Apple therefore offers roughly $120 in cash and investments within each individual share ($110.10 cash and investments / 929.3 million shares outstanding = $118.48 in cash and investments per share).
In other words, Apple stock is cheap, and we must trust that management will continue to maximize the company's long-term value for shareholders. Grudgingly, I have no other option, but to accept my $2.65 quarterly dividend, and maintain my faith in Apple as a solid, long-term investment.