AAPL’s dividend: implications

the AAPL announcement

Yesterday morning, AAPL announced that it will initiate a $2.65/ share quarterly dividend, starting during the July accounting period.  The company says it will also repurchase $10 billion in stock over the coming three fiscal years.  Together, the two moves will absorb $45 billion in domestic cash.

my thoughts:

the stock buyback

The dividend is a more important signal about future earnings.  But the description of the stock buyback also says something important, and admirable, about the company’s management.

Most firms try to describe stock buybacks an altruistic move on their part, as “returning cash to shareholders.”  They argue that dividend payments create a tax liability for recipients while stock buybacks do not, and intimate that this is the main reason for their action.

The tax stuff is true. But the rest is, at best, nonsense.

Companies pay their employees, and particularly their executives, in two ways:  with cash; and with stock options.  The latter gradually transfer ownership of the firm from portfolio investors to employees.  In fact, many companies in the tech world have target percentages for this transfer in mind when they issue stock options.  The main–unspoken–purpose of stock repurchases is to keep the total number of shares outstanding stable, and thereby disguise the change in ownership that is taking place.

APPL is the first company I’ve seen that’s completely honest with shareholders.  AAPL says its share repurchases have “the primary objective of neutralizing the impact of dilution from future employee equity grants and employee stock purchase programs.”  The asset transfer effect, by the way, is a miniscule .5% or so per year in AAPL’s case.

the dividend

The initial payment level of $10.60/year implies to me that AAPL management thinks profits will be a lot better than the market now expects.  Here’s why:

Two basic rules about dividends are:

–they’re supposed to be paid out of profits, and

–they should be set at a level that’s easily sustainable, and that can rise.  Very little is worse for a company than having to cut, or eliminate, a dividend.  A prudent firm–and AAPL is one–would have already thought carefully about a pattern of future dividend increases when setting the initial payment amount.

AAPL’s situation

At the end of the December 2011 quarter, AAPL had 932 million shares outstanding.  Let’s say that rises to 940 million by the time it begins paying dividends.  $2.65/quarter x 4 quarters x 940 million shares = $9.96 billion in annual dividend payments.

AAPL will most likely have chosen the current dividend payment based solely on its estimate of  sustainable US earnings.  Why?  Dividend payments from a US corporation have to use US-domiciled cash.   Yes, AAPL has $33 billion in the bank in the US already–enough to pay the current dividend for over three years or supplement a payout that exceeds US-generated funds for far longer than that.  But what would AAPL do after the US cash runs out?  …cut the payout?  No way.  …repatriate funds from abroad, losing 35%  to federal taxes?  Probably not.

Therefore, it’s a reasonable assumption that AAPL considers a recurring $10.60 a share from the US each year as “in the bag.”  If it were me making the decision, I wouldn’t want to set the payout at 100% of US earnings.  I’d like a cushion.  Arguably, the US cash on the balance sheet is enough of a safety margin, but why take the risk?  I’m thinking the payout is being set at more like 75% of US earnings–which also leaves room for a dividend increase next year.

doing some arithmetic

Let’s try to use the $10.60 a year to calculate what AAPL must be thinking about its total earnings.

AAPL presently earns a little more than a third of its revenues in the US.  As Asia increases in importance to the company, the domestic percentage will likely fall. Assume that the US is 30% of the AAPL total for fiscal 2012 and 28% in fiscal 2013, with overall earnings growing, say, by 15%.

Case 1:  low-balling      AAPL has decided to pay out 100% of its current US earnings in dividends.

That would imply AAPL earns $35.33 this fiscal year and $43.50 next.

I think this is would be, in AAPL’s view, for all practical purposes the worst possible case.

Case 2: realistic     AAPL has decided to pay out 75% of its current US earnings.

That would mean $47 in eps for this fiscal year and $58 next.

This compares with the current analyst consensus eps of $43.14 for fiscal 2012 and $48.44 for fiscal 2013.

AAPL insiders more bullish than Wall Street?  I think so

Case 1 yields no useful information, since consensus estimates are already substantially higher.  Case 2, which I think is considerably more probable, would imply that AAPL’s board and management are both noticeably more bullish on company prospects than Wall Street.  AAPL insiders can be as wrong as anyone else.  In this case, however, they have a ton more pertinent information to work with than you and I do.

3 responses

  1. I agree, a very good analysis.

    I disagree with @CanadianMDInvestor in that a yield equal to the S&P 500 isn’t as important as being responsible with the cash they have on hand. As Microsoft has seen, when the cash gets to a level of insanity, shareholders / government / etc. will start to cry out for a breakup, or something else that makes no sense.

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