Apple Is Not A Retirement Stock

| About: Apple Inc. (AAPL)

With the brutal clobbering Apple (NASDAQ:AAPL) has experienced recently, dipping below $500/share for the first time in almost a year this week, many market pundits are now calling the silver lining to the carnage: Apple's steep price decline has left its dividend yield at an attractive 2%. Parsimony Investment Research goes even further, identifying the dividend as "the most compelling reason to buy Apple right now." It's easy to see the appeal that a stock like Apple might have for dividend investors: at 2%, the yield just makes the cutoff for many investors' portfolios, and the dividend is funded by a low payout ratio of less than 25%, which means it has a lot of room to grow. Plus you get to own one of the most consistent long-term winners in the stock market, even after taking recent setbacks into consideration - hell, many dividend funds were secretly buying Apple before it announced a dividend.

I believe that dividend investors should exercise caution before rushing into Apple. While the stock does represent a tempting value right now, it is a poor fit for the portfolios of many dividend investors, who often choose a dividend strategy because of an ultimate goal to create a safe, stable stream of income, possibly to fund their retirement. Although Parsimony uses Apple's earnings history as evidence to project stable cash flows for the future, its report completely neglects to mention some huge risk factors at play that are threatening the company's business right now. While there are many good things to be said about Apple, this is not a stock you want to buy for your retirement portfolio.

The first issue is Apple's colossal margins compared to its competitors. Court documents publicized after Apple's intellectual property dispute with Samsung (OTC:SSNLF) revealed that Apple grosses a whopping 49-58% on the iPhone, its biggest moneymaker. While this indication of outperformance is sexy to a growth investor, what is normally an asset suddenly becomes a liability when the stock is evaluated from the perspective of dividend investing. When you're looking for a safe stock, you want small margins, not large ones, because the small margins have much less room to fall. Take a company like Wal-Mart (NYSE:WMT), a classic dividend stock - with a profit margin of 3.5%, Wal-Mart is already pricing its products barely above break even. Investors don't really have to worry about a similar business coming in to undercut Wal-Mart's prices, which are already rock-bottom.

However, the threat of competition is very real for a company like Apple, who has to stay one step ahead of the pack if it wants to maintain its huge margins. One of the reasons the stock has taken such a beating lately is because of margin concerns after last quarter's earnings release and subsequent guidance. The sustainability of its margins has always been the primary concern for Apple investors. If Apple loses pricing power due to competitor inroads, its margins will plunge, and investors making projections based entirely on past earnings will learn the harsh reality of what happens when you look at stocks through the rearview mirror.

Apple's business is unique in that its margins are actually partially protected by phone subsidies. Although Apple's iPhone division makes more money per device than any other handset manufacturer, its phones don't actually sell for more than a top-of-the-line Android phone. This is what allowed the company to grow so large so fast, because it can reap the ARPU of a high priced product and the volume of a low priced product, with wireless carriers paying the difference.

This business model also means that Apple doesn't need to justify selling a $600 iPhone to sustain its margins - it just has to make sure its $200 iPhone is popular enough that no carrier can afford to terminate subsidies without losing tons of subscribers. However, this model comes with its own risk: that carriers will find some way to reduce, or even eliminate iPhone subsidies. T-Mobile has already done it, and the other carriers are watching closely. It's impossible to pinpoint the precise downside for Apple's bottom line if US carriers ever decide to scrap subsidies for the iPhone, but not being able to put a number on it doesn't mean it won't be considerable.

All these risk factors mean one thing: that Apple has no place in a standard dividend portfolio, which prizes sustainable cash flows above all else. Now here's the kicker: I actually own Apple in my portfolio, despite everything I've mentioned so far (although it's far from my biggest position). I think every Apple investor needs to avoid the cult mentality and educate himself on the risks associated with the company, but I still believe that the stock is a worthwhile investment despite these risks. Even today, there is no logo in tech as valuable as the apple with a bite taken out of it, and I've rarely seen any company so committed towards excellence. However, I also have a huge tolerance for volatility, don't need to spend any of my dividends, and have a long enough time horizon to stare down a turbulent market. While I own Apple myself, I would not buy it for my father's portfolio (of course, my father likes to buy even riskier instruments like triple leveraged ETFs, but hey, what can you do).

One day, Apple may become a good dividend stock. I believe that CEO Tim Cook is much more committed towards shareholder return than Steve Jobs, and the recent hiring of Luca Maestri as corporate controller may indicate a cultural shift towards fiscal responsibility in the company. There's also something to be said for the $100 billion in the company's bank account. That's why I think dividend investors should definitely include the ticker on their watch lists - but when it comes to actually investing in Apple? Wait, watch, and see. It'll probably still be a bumpy ride for awhile.

Disclosure: I am long AAPL. 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.

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