Tag Archives: Dividends

AAPL’s dividend: implications

March 20, 2012 By in earnings conference calls, Recent Market Action, Stock ideas Tags: , , , , , , 3 Comments

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.

you may own more AAPL stock than you think

March 15, 2012 By in Dividends, Industry Analysis, Investment firms, Portfolio management Tags: , , , , , , , , Leave a comment

Yesterday’s Wall Street Journal has an article in which it looks at the investment vehicles that hold AAPL shares.  A third of equity mutual funds sold in the US hold AAPL; 20% of hedge funds claim it as one of their top ten long positions (given the sketchy nature of hedge fund disclosure, I wouldn’t bet the farm that this is figure is entirely accurate, though).

what Apple is

Just to be clear,

–Apple is a US-based company.

–It’s incorporated in California, where its headquarters is located.

–Primary trading is on NASDAQ.

–AAPL doesn’t pay a dividend.

–AAPL isn’t just a large-cap stock.  It’s a MEGA-cap stock.

The median market cap for members of the S&P 500, the large-cap index, is a touch under $12 billion.  AAPL, in contrast, has a market cap of close to $550 billion, or 45x the median.  The company has no debt and over $100 billion in cash on its balance sheet.

what funds hold AAPL shares

Despite this description, according to the WSJ the following kinds of funds hold AAPL shares:

–40 funds that focus on dividends in selecting stocks

–50 funds that specialize in small- or mid-cap stocks

–3 Fidelity funds that specialize in Europe

—international funds, including the Ivy International Growth and the Waddell & Reed Advisors International Growth

–the BlackRock High Yield Bond Fund, a $5.9 billion junk bond fund that held $8.3 million in AAPL shares at 12/31/11.

how can these funds do this?

In one sense, it’s crazy.  How can you trust a manager who says he’s going to buy small, fast-growing stocks with market caps below the S&P 500 median for you, after you see his outperformance is coming from a half-trillion dollar stock?  In this regard, the BlackRock High Yield position that the Journal reports is extremely hard for me to understand.  Ignore the fact that it’s a bond fund owning stocks.  The AAPL position size is so small, at 0.14% of assets, that it’s immaterial to fund performance.  There has to be more to that story.  One guess is that the position is much larger today.

In another, narrowly technical, sense–even though the fund name, and presumably its marketing materials, don’t give the slightest hint that this may be going on–fund rules doubtless permit the purchases.

If you read the prospectus carefully, it will surely say something like the fund will achieve its objective (of buying small-cap, or foreign stocks…) by having at least, say, 65% of the fund assets invested in the specified kind of securities.  It will go on to state that the fund reserves the right to invest the rest of the fund in other stuff.  (By the way, the prospectus may also say that for temporary defensive purposes, the fund has the right to redeploy its assets entirely to cash or to Treasury bonds, or some other presumably safer form.)

why do they do this?

I think the obvious answer is the correct one.  The portfolios in question want to achieve a performance advantage, either over the other funds in the same category or against their benchmark index, by buying securities that are outside their normal investment universe.

Is this illegal?  No, because of the prospectus disclosure.

Is it unethical?  In my view, yes.  An international manager might try to argue that because APPL manufactures and sell products abroad, it’s actually a foreign stock.  Someone might buy that explanation.  It certainly wouldn’t fly in the institutional pension management world, however.  And small-cap managers, who typically charge higher fees to compensate for the extra work involved in small-cap, don’t have an ethical leg to stand on.

what to do

Figure out how much AAPL you actually own and ask yourself if you’re comfortable.

Remember that any S&P 500 index vehicle you hold is about 4.5% AAPL.  AAPL may also be 20+% of any tech fund you own.  And, as the WSJ article suggests to me, it might be wise to take a quick look at all your mutual funds or ETFs to see how much AAPL is in them.  You can get the information from the management company website, the SEC Edgar site, or to the latest report you’ve gotten from the fund itself.

higher taxes on dividends? –implications for stock markets

February 17, 2012 By in cash flow/share vs. earnings/share, Constructing a Portfolio, currency effects, Current Market Thoughts, Dividends, Industry Analysis, Investment firms, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , Leave a comment

the Obama proposal

President Obama has recently proposed that the current tax preference for corporate dividends paid to individuals be eliminated.  Instead of being taxed at most 15% of the amount received, dividends would be considered ordinary income and taxed by Washington at as high a rate as around 40%.

Personally, I’d prefer an overhaul–and simplification–of the current tax code instead of tweaks around the edges.  Rather than putting a foot into the  the quagmire of possible political motivations, however, let’s just take a look at what I think are likely results for US capital markets if it’s implemented.

what doesn’t change

1.  Tax-exempt and tax-deferred accounts would be unaffected.  For pension plans, 401ks and IRAs, and for non-profits, it will continue to make no difference whether they make money in the form of interest or dividend income, or of short-term or long-term capital gains.

2.  Aging Baby Boomers are developing an increasing preference for steady income over capital gains, which are sometimes there, sometimes not.  That won’t change either.

what does

3.  I think the biggest effect will be on company decisions to start making dividend payments or to increase a payout they already have.

It seems to me that most publicly traded corporations recognize the Baby Boom-induced change in investor preferences now happening in the US.  Understanding that a substantial, and rising, dividend is a positive for their stock, companies have been happy to return profits to shareholders this way.  They do this despite realizing that if you combine federal and state/local income levies, up to 25% of the payout will go to the taxman.

If dividends lose their tax preference, the percentage taken by the taxes will approach 50%.  That means a big drop in what the shareholder will retain, both numerically (a third) and psychologically.  For most companies, I suspect, it will tip the balance in favor of devoting free cash flow to share buybacks rather than dividend increases.

For my money, that takes a lot of the shine away from what I consider to be the most attractive part of the dividend-stock universe–companies with above-average dividends today and for which you can reasonably project a quickly rising free cash flow over the next few years.

4.  If the government continues to  keep interest rates at emergency lows and, by accident or design, it also removes much of the incentive for individuals to buy dividend-paying stocks, how do investors adjust?  Maybe there’s a boost in demand for junk bonds, although income-oriented investors have been buying riskier forms of fixed income for a long time.

I think biggest effect would be for investors to broaden their horizons further.  The 7%-8% yields on EU telecom stocks will suddenly look more attractive, despite currency risks.  So, too, emerging market securities, both bonds and dividend-paying stocks.

5.  Looking at #3 another way,  provided they’re large enough to lower the share count, stock buybacks raise earnings per share.  All other things being equal, that should mean a higher per share stock price.  If so, the higher share price would likely offset some or all of the negative effect of dividends increasing at a slower rate.  In other words, the mix of returns (price appreciation + dividend income) changes, and in a way that increases risk.  But the crucial investment question is whether the total return from both sources will be higher or lower than before.

No one knows the answer.  But if the total return is lower–that is, if the effect of higher taxes on dividends is to decrease the long-term value of US equities–then one would expect US investors of all stripes to look increasingly to stock markets outside the US.  In addition, on the margin, US companies might also begin to look to foreign venues to raise new capital, if they could achieve higher prices for their stock by doing so.

My bottom line:  this proposal is one to watch closely.  Like a snowball that starts rolling down a hill, its consequences could be far greater than just to raise taxes on older, upper middle class city dwellers.

searching for yield in a zero Fed funds rate world

February 13, 2012 By in Constructing a Portfolio, Current Market Thoughts, Dividends, Strategy, Utilities, Wireless Tags: , , , , , , , , Leave a comment

conventional wisdom

Two traditional general rules about the appropriate allocation between equity and fixed income are:

1.  Take your age in years.  That percentage of your assets should be in fixed income; the rest can be in equities.  A thirty-year old, for example, should keep 30% of his assets in bonds and 70% in stocks.  A seventy-year old should have the reverse proportions.

2.  For a retiree, figure what your yearly expenses are.  Keep enough fixed income so that the interest earned will cover these expenses; the rest can go into riskier assets like stocks.

Neither rule applies in today’s world, however, at least in my view.

Only a lottery winner has the luxury of using #2.  Fifteen years ago, when the 10-year Treasury was yielding 8%, $1.25 million worth of them would generate $100,000 in interest income.  Nowadays, you’d need a $5 million investment to earn the same.

Both rules subject the follower to considerable risk as/when interest rates begin to rise.  My friend Denis Jamison deals with this subject in detail in his recent posts on PSI.    …his conclusions.

my quandary

One of my former employers notified me recently that I’m being removed from participation in its fixed income pension plan.  I can either take lump sum distribution or buy an annuity.  I’ve chosen the former, which I’m rolling over into an IRA.

I want to keep the IRA money in income-generating assets, to counterbalance to some degree my growth investor desire to own stocks.

Believe it or not, it takes a month for my old company to process my request.  Also, quaintly enough, it will issue a physical check and send it in the mail to my IRA account.  Looking on the bright side, this gives me some time to figure out what to do.

So I’m looking for dividend-paying stocks.  I’m not the only one, of course.  And with this account I’m starting at a time when the search for such equities by individual investors is close to entering its third year.  Has everything been picked over already?

first thoughts

My preliminary look around for information has turned up two interesting articles:

-the first comes from BCA Research, an independent organization headquartered in Canada (BCA stands for Bank Credit Analyst, its best-known publication).  BCA continues to be very fundamentally sound.  At one time it served primarily individuals and was somewhat technically-oriented and decidedly bearish in tone.  Not so much any more.  Today’s clients are mostly institutions.

In a February 2nd article titled US Equities:  The Total Return Trap,  BCA opines that traditional high income stock groups–utilities, telecom and REITS–are currently overvalued.  It recommends looking for yield among pharmaceuticals, integrated oils and hypermarkets.

–A February 5th piece in the Financial Times points out that significant dividend yields are available among stocks in the EU and in the Pacific.  The article lists the following current yields on various FT regional indices:

Europe (ex the UK)     3.80%

UK          3.40%

Asia Pacific (ex Japan)          3.16%

Global          2.70%

Japan          2.51%

US          1.96%.

my first stops

My order of preference is:  US, UK, Asia ex Japan, Europe.

I’m not so keen on Japan.  I think companies there prefer to pile up cash rather than pay dividends.  The high yield is more a function of wretched stock market performance than rising payouts.

I don’t have strong thoughts on the relative strength of the € vs. the $.  My hunch is that the € is going to be relatively weak, though, undermining the attractiveness of any dividend payment to a dollar-oriented recipient.  If we’re going to enter an extended period of economic stagnation in Euroland, much like the “lost decade(s)” in Japan, however–and I think that’s the most likely scenario–one can reasonably make the argument that, like the ¥, the € could show surprising strength.   I just don’t know.  Until I have more conviction, why take the chance?

The UK is a very income-oriented market and doesn’t carry the same degree of currency uncertainty as the Eurozone, in my opinion.

I’ve got a couple of weeks to do some research.  I’ll write more as I make progress.

what dividend increases are saying about today’s stock market

September 6, 2011 By in Dividends, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , 1 Comment

dividends

I’ve posted on the topic of dividends a couple of times before.  This is probably the most complete.

Generally speaking, when a company begins to mature and is generating more cash than it can profitably reinvest in its business, it should return the extra amount to shareholders.  In some cases, obstacles may prevent this:

–shareholders may not want the money (investor preferences can change one way or the other with demographic and economic conditions);

–tax rates on the receipt of dividends may be punishingly high;

–the funds could be stashed away abroad; or

–management may prefer profitless, but ego-flattering, empire-building to doing what’s best for the firm’s owners.

But, generally, companies do pay dividends.  With the Baby Boom generation moving into retirement age, American investors seem to me to be more interested in dividend income than at any time over the past twenty-five years.

share buybacks

(The other main way of “returning” cash to shareholders is through share buybacks.  In most cases, I’m not a fan.  Yes, they may result in less tax being paid, but I think managements mostly use buybacks as a way of stabilizing the share count–that is, disguising the degree to which stock options gradually shift ownership of the firm away from current shareholders and into the hands of management.)

what dividends signal

There are three key features of dividends, and especially of dividend increases, to be aware of in today’s market:

–the dividend is set by the board of directors, in consultation with management–that is, by the people who are usually veteran participants in an industry and who know the detailed inner workings of their firm inside-out.

–a primary goal of the board is to set the dividend at a level that can be sustained indefinitely.  Therefore, dividend increases signal the company’s belief that business is better than it was and that the firm has entered into a permanently higher level of cash generation.

–dividends are paid out of profits, so a dividend increase signals not only higher levels of cash coming in, but also higher profits.

what’s happening with dividends today?

According to Howard Silverblatt of Standard and Poors:

1.  Of the 389 dividend paying members of the S&P 500, 243 had initiated a dividend or raised their payout rate through the end of last month.  That’s 68 more companies (+39%) than this time a year ago.  Only 4 had decreased the dividend.

2.  The net increase in funds committed to be paid out for the index is $28.7 billion through August.  That’s over double the level of a year ago, and 35% higher than full-year 2010.

3.  The total dividend payout in dollars of the S&P this year is almost–but not quite–back to the level of 2007.  The shortfall of about $16 billion is (more than) entirely due to the financial sector, which contributed 29% of total dividends in 2007 vs. 12% this year.  Ex financials, dividends are higher today than before the financial crisis.

4.  The yield on dividend-paying stocks is 2.6%.  That compares with the ten-year Treasury at 1.99% and the thirty-year at 3.3%.

conclusion

Yes, the US economy may have shifted into a lower gear over the first half of 2011.  But the actions of company directors in raising dividends sends a strong signal that corporate profits are in much better shape than media headlines suggest.