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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More…)
I don’t care what I own as long as I own it at the right price, and at the right risk profile, to have a shot at making serious profit without sweating bullets each night wondering what sort of bad news will hit the stock that I’ve put good money into. When everyone was in love with Apple (AAPL) at $700, claiming that it was a no-brainer run to $1,000 (a $1T market capitalization for a company that makes cell phones and shiny computers), I was incredibly skeptical. However, at the most recent closing price of $442/share, I am much more intrigued, and much more willing to consider allocating a portion of my portfolio to this profit-generating machine.
I Really Like Dividend Growth
One of the key characteristics that I like for my bigger positions is dividend growth. The reason I like dividend growth really has nothing to do with the actual dividends that I receive! $10,000 worth of Apple (22 shares as of the most recent close) is enough to put about $265 (less after tax if you’re not using an IRA) into your brokerage account each year. That’s nice, but considering that my 22 shares are likely to move in value by that much in a day (and as of late, the odds are in favor of a downside move rather than an upside one), that’s not really a compelling sell.
But you know what would be really compelling sell? Knowing that every year, Apple will keep raising the dividend that it pays per share. If you start early enough (or if you have enough capital to begin with), then a company that increases its dividend regularly offers the following benefits:
- The yield on your initial capital outlay increases with each dividend increase, which supercharges the initial investment
- The dividends are likely to be reinvested into dividend paying securities, which adds the power of compounding to the mix
- Dividend increases usually signal strengthening corporate health (profits, sales, and such are expected to be moving right along with the dividend increases), which moves up the trading range for the stock
Right now, Apple’s dividend yield is actually a little bit underwhelming. With the amount of cash this company adds to its balance sheet each quarter (that sits there making 1-2% in treasuries), it should really be doling more out to its investors. Now, the dividend is pretty new, so I certainly understand that the company wants to do its traditional thing and “under promise, over deliver”, likely with consistent dividend increases over the next couple of years .
With that bet in mind, and with Apple’s shareholder meeting coming up soon, I would expect the first dividend increase to be announced very soon. This leads me to want to analyze Apple’s dividend growth prospects a bit more deeply.
What If The Profits Get Cut In Half?
The big fear — and why Apple’s P/E sits at a paltry 10 — is that its immense profitability will start to wane going forward as competitive pressures mount. I am not ashamed to admit that I well and truly believe this. Apple’s gross margins in the most recent quarter saw a sequential and Y/Y drop, and while many believed that this was a “one time only” startup drop, the company once again guided for historically weak margins (and EPS estimates are actually now looking for a Y/Y decline). The competition is coming.
So to really evaluate Apple from a dividend growth perspective, we have to see just how much Apple could afford to pay if, say, profits were cut in half (very unlikely).
Assuming a payout ratio of 50% on EPS of $22 gives us $11/share, or a little bit more than what Apple is paying today. I believe that the firm’s current sub-30% payout ratio has a lot of room to stretch, and even at 50% would leave more than enough to invest in whatever strategies the company needs to (and remember folks, the company has $136B on the balance sheet). At a 50% payout ratio on today’s earnings, Apple would be distributing $22/share annually, or nearly double the current dividend. This means that even if Apple’s net income stays more or less flat, it can afford to increase its dividend by 10% each year for 7 years.
Now, if Apple actually uses the cash on its balance sheet to go buy some businesses that would be accretive to EPS (it’s not shameful to grow by acquiring other businesses), then the EPS line could also continue to grow, and Apple could do a double-play with steady payout ratio increases coupled with EPS growth!
In short, despite the margin compression in the phone/tablet space, Apple has so much sheet money on its books that it could find ways to juice profitability through smart acquisitions, while at the same time becoming more generous with its cash.
The Bet Is Now On Dividend Growth
Forget high double-digit revenue growth — that’s for the small and mid-cap companies. For a $400B+ company taking in nearly $200B in revenues, this is not a sustainable trend, even if Apple could pull it off for a few more quarters or even years. Investors buying shares in Apple should do so for the value and for the strong possibility of dividend growth.
Viewed in this light, Apple represents an interesting gamble near 52-week lows. However, the types of investors who previously bought into Apple consciously did not want that kind of a “boring” investment. I get the feeling that these people are nearly flushed out though, all headed into names such as Netflix (NFLX), Green Mountain Coffee (GMCR), and Google (GOOG).
If you’re ready to accept Apple for what it is, then now may be a good time to consider picking up shares. However, it’s up to Tim Cook and team to show that they’re really committed to delivering shareholder value. They have a lot of levers that they can pull, but will they pull them?
That’s a call you’ve got to make.