Is Apple Becoming A Dividend Stock?

 |  About: Apple Inc. (AAPL), Includes: KO, PG
by: Philip Mause

In the modern world of finance, everything seems to be happening faster than before. It used to take years for a "growth" stock to mature and become a "dividend" stock. The theory was that the two categories were mutually exclusive for two reasons. First of all, growth stocks didn't pay dividends because they needed the cash to finance expansion. Secondly, growth stocks traded at such high price earnings ratios that it was impossible for them to generate an attractive dividend yield. Over the years, as a company matured, the growth stock would become a dividend stock much as a fast ball pitcher would become a finesse pitcher in baseball.

Apple (NASDAQ:AAPL) recently started paying a dividend and initially the expectation was that it would be relatively small and not generate the kind of yield that dividend investors covet. However, recent developments have conspired to move AAPL into the range of being an attractive dividend stock. This is largely because AAPL has the potential to increase its dividend substantially. It is operating at a relatively low "pay out ratio"; the pay out ratio is the percentage of earnings being paid out as dividends. In the case of AAPL, the pay out ratio - even using trailing earnings - is 24%.

The table below is designed to compare AAPL with two stocks that are generally favored by dividend investors. There are 4 rows - one for AAPL as it is today, one assuming AAPL starts paying dividends at a 50% pay out ratio, one for Procter & Gamble (NYSE:PG) and one for Coca-Cola (NYSE:KO). In each case, I have listed Thursday's closing price, the dividend, the current yield, the trailing earnings per share, the payout ratio, the net balance sheet cash, the number of quarters of dividends that could be covered entirely with net balance sheet cash if earnings were to cease.

Price Div. Yield Earnings PR BSC C1/4s
AAPL $537.35 $10.60 2.0 $44 24% $121B 49
AAPL 50% $537.35 $22 4.1 $44 50% $121B 23
PG $66.91 $2.25 3.5 $3.59 63% -$27B -----
KO $36.36 $1.02 2.8 $1.91 53% -$5B -----
Click to enlarge

AAPL could increase its dividend to produce a 50% payout ratio and yield more than PG or KO. It would have a dividend yield of over 4% - a level at which a dividend yield itself tends to create a floor for the stock price. It would have the added advantage of a hoard of balance sheet cash sufficient to keep the dividends going for nearly 6 years even if earnings disappeared. At a 50% payout ratio, AAPL would still be paying a smaller percentage of its earnings as dividends than either PG or KO.

Could AAPL, as a company which is growing rapidly, increase its dividend to $22 a share without eating into the funds necessary to finance its explosive growth? The answer is a resounding, "yes". Putting aside AAPL's $121 billion cash hoard, AAPL's cash flow is more than sufficient to support a $22 a share dividend and its capital expenditures. In fiscal 2012, AAPL had net income of some $42 billion and capital expenditures (Capex) of $8.3 billion. AAPL also had depreciation of $3.3 billion in fiscal 2012, so the cash flow available to owners was some $37 billion. A $22 a share dividend would cost roughly $21 billion and would leave more than $16 billion free cash flow after Capex and dividends. AAPL could implement the policy I describe and increase dividends to $22 a share and it would still throw off considerable excess cash after Capex. Given that AAPL already has $121 billion of net balance sheet cash, this would still be a very conservative dividend policy.

AAPL may not take action to increase its dividend but the table above demonstrates that it has not only excellent protection for its existing dividend but also the readily available means (both current cash flow and balance sheet cash) to increase that dividend. The 24% payout ratio together with an enormous and growing pile of balance sheet cash creates the opportunity and may, indeed, create a mandate for increasing dividends toward the 50% payout ratio level. The higher dividend would tend to put a floor under the price of the stock and stabilize the market for AAPL.

When compared with PG and KO, AAPL certainly seems the better bet to increase its dividend. I know that dividend investors often take a Jerry Maguire approach ("Show me the money!") but dividend investors also tend to be patient investors and at $537.75, AAPL looks tempting as a source of future yield.

One investment strategy I have discussed previously is called "dividend anticipation" in an earlier article. It involves buying a stock which does not pay a dividend in the anticipation that it will reasonably soon start paying a dividend and then trade up. AAPL may present an analogous opportunity here to anticipate dividend increases.

There is, of course, some risk in this strategy but there is also risk in buying a stock with net balance sheet debt and a high payout ratio and, if there is one thing we are learning in this market, it is that there is no free lunch. AAPL presents an opportunity to generate yield as we move forward which may never be attractive on a "current price" basis but, if locked in at today's prices, may be very, very attractive on an "original cost" basis. I never thought I would be talking about buying one of the best growth stories of this short century for yield, but we live in crazy times, don't we?

Disclosure: I am long AAPL, PG, KO. 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.