Apple’s decision to do a 4-to-1 stock split was an attempt to increase demand for its shares. The company’s executive team was clear about it: “we want Apple stock to be more accessible to a broader base of investors”.
While the move may have a positive psychological impact on investors, as I argued a few days ago, I think Apple could act even more boldly. Considering how much cash the company continues to produce, even during a pandemic year, I believe that it could attract a large number of income-seeking investors to its stock by doubling the dividend payments. In my view, the strategy would open the floodgates to much more stock demand from a group of investors that have little motivation to buy shares today.
The case for higher dividends
Apple started to pay a dividend in 2012, and soon the yield reached a peak of 3% that toppped the S&P 500’s by about one percentage point in mid-2013 (see graph below). However, the spread has since been flipped upside down. Today, the broad market offers an yield of 1.8% that is more than one percentage point higher than Apple’s 0.75% – which, in turn, is barely above the all-time-low 10-year treasury rate.
With interest rates on fixed income instruments so low, I find it very likely that many investors, particularly those in the higher age groups who are in or nearing retirement, will need to move up the risk spectrum and find reliable sources of periodic cash payments elsewhere. So far, Apple has been proving to be a cash-generating machine, but not an appealing cash payer to shareholders (other than indirectly, through share buybacks).
Let’s face it: at a market cap of nearly $2 trillion, double what it was one year ago, and annual revenues of over $260 billion, Apple can only play the growth game for so long. Sooner of later, the stock will need to find demand from a different investor demographic group. I believe that the time could be now.
Assuming that Apple shares remain unchaged, doubling the dividend payments would effectively double the yield to 1.5%. Even though this rate would still be lower than the S&P 500’s, it would be a solid 30 basis point higher than the 30-year treasury rate. At this point, dividend investors could start to pay more attention: great company, solid balance sheet, capital appreciation potential and treasury-beating yield.
Can Apple afford to double dividends?
Let’s do some math.
In fiscal 2019, Apple spent $14 billion in dividend payments and $67 billion in share repurchases. At the same time, the company produced around $59 billion in free cash flow – suggesting that some debt issuance was needed to finance Apple’s cash return policy last year. Net cash (cash and marketable securities minus debt) was $98 billion at the end of fiscal 2019.
Using the numbers above as a base, I propose the following exercise. Suppose that:
- dividend payments doubled overnight to $28 billion, and grew at 5% per year thereafter;
- share buybacks stayed flat going forward;
- stock price increased at a market-beating annual pace of 12%;
- FCF grew at a modest pace of 10% indefinitely.
I projected Apple’s dividend payments and net cash position from the assumptions above through fiscal 2030. For simplicity, I kept other cash variables out of the equation, including M&A and other smaller financing activities. The graph below paints the picture.
Notice that, due to the higher dividend commitments, Apple’s net cash position would deteriorate over the next five years. However, if the company could maintain the 10% cash flow growth rate intact, the balance sheet would start to improve once again by 2025.
Of course, for an added buffer, Apple could take the foot off the share repurchase pedal. For example, were the company to reduce stock buybacks immediately by 20% and keep the cash outflow constant from that point forward, net cash would bottom just above $60 billion before recovering once again.
The case against higher dividends
Stay tuned for part 2 of this article, in which I play devil’s advocate and list three reasons why Apple might not want to double its dividend payments. Check the Apple Maven’s website, and expect the article to come out within the next day. In the meantime…
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(Disclaimers: the author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting The Apple Maven)