Examining Apple's Dividend Strategy
Apple's board is expected to authorize an increase in the company's quarterly cash dividend later this month in conjunction with 2Q16 earnings. Ahead of this event, I examined Apple's dividend strategy. All signs point to Apple relying on a stable dividend policy in which dividend expense follows an existing long-term growth trajectory rather than near-term earnings volatility. By finding this dividend growth trajectory, it is possible to for look subtle shifts in trajectory going forward. These shifts will provide clues as to how management views long-term business prospects and profit opportunities.
Dividend Growth
In order to find Apple's future dividend growth trajectory, we must first take a look at the company's historical dividend growth rate. After a 17-year hiatus, Apple reinitiated its quarterly cash dividend in 2012. Since that time, Apple has paid out $42 billion ($6.84 per share) of dividends while the share price increased approximately $26. Accordingly, the dividend has been responsible for approximately 20% of an AAPL shareholder's total return.
Apple has increased its quarterly cash dividend annually beginning in 2012:
- 2012: $0.38
- 2013: $0.44
- 2014: $0.47
- 2015: $0.52
In order to calculate Apple's historical dividend growth rate year-over-year, we take quarterly cash dividends per share and convert them into an annual total, keeping in mind that Apple increases the quarterly dividend midway through its fiscal year:
- 2013: $1.64
- 2014: $1.82
- 2015: $1.98
We can now calculate the year-over-year growth rate for total dividends per share paid on an annual basis:
- 2014: 11%
- 2015: 9%
Apple discloses in its financial filings that it intends to increase the quarterly dividend annually. It would appear from looking at 2014 and 2015 growth trends that Apple management is on a trajectory in which it will increase its quarterly dividend by approximately 10% each year. However, there is more to the story.
Apple's share buyback is playing a significant role in defraying the total cost of these 10% dividend increases. As Apple buys back its shares, the number of shares outstanding is reduced. This leads to Apple paying out fewer dividends, all else equal. As long as Apple buys back shares, management will continue to have greater leverage when it comes to raising the quarterly cash dividend. Said another way, current shareholders are seeing an indirect benefit from the share buyback by receiving higher dividend payments per share.
To see how share buybacks have made it cheaper for Apple to pay higher cash dividends per share, consider the amount Apple spends on cash dividends annually:
- 2013: $10.6B
- 2014: $11.2B
- 2015: $11.6B
Since these totals exclude the impact from share counts, we can calculate the growth rate in Apple's annual dividend expense:
- 2014: 6%
- 2015: 4%
Even though the Apple board has been increasing the quarterly cash dividend by approximately 10% over the past two years, the total growth in Apple's dividend expense has actually been only approximately 5% per year. The reduction is due to a lower share count produced by Apple's share buyback. We can now use this 5% dividend expense growth rate as the base line when plotting Apple's future dividend growth trajectory. However, we first need to measure Apple dividend sustainability.
Dividend Sustainability
In order to judge how sustainable it is for Apple to increase its dividend expense by 5% each year, we need to look at Apple's dividend payout ratio. As the name implies, a dividend payout ratio shows the percentage of a company's total net income that is paid to shareholders in the form of cash dividends.
Apple's dividend payout ratio (dividends / net income) has been trending down:
- 2013: 29%
- 2014: 28%
- 2015: 21%
The declining dividend payout ratio is a sign of improving dividend sustainability because it suggests Apple has remained conservative with its dividend growth policy even in the face of strong earnings growth. When compared to industry averages, Apple's 21% dividend payout ratio is only marginally higher. This is a byproduct of Apple following a stable dividend policy in which the company strives to maintain a certain level of consistency when it comes to dividend expense growth. Even though Apple saw a boost in earnings in 2014 and 2015, management will likely follow its existing strategy of running with a modest 5% increase in dividend expense. There are a few reasons to do this with the main one being that investors value predictability. Apple avoids having to make sudden dividend swings in the future, including cutting the dividend when earnings slow.
The primary takeaway is that future Apple cash dividends will not be determined solely by the company's earnings. Instead, Apple dividends will be based on a stable growth policy in which management targets a consistent dividend growth rate that does not follow the cyclical nature of its business. By selecting a dividend that appears to be well within their capability of paying, management is indicating they are comfortable increasing their dividend expense by 5% each year. Going forward, management can use the dividend payout ratio as a periodic check to make sure that the company is not playing it too safe with its dividend or vice versa, putting itself in financial distress.
Charting Apple's Dividend Trajectory
Since we now have a sustainable, dividend expense growth rate in hand, it is time to plot Apple's future dividend trajectory. We assume Apple maintains its 5% growth rate in dividend expense going forward (represented by the blue line in Exhibits 1 and 2) because of Apple's stable growth dividend policy. In addition, two other dividend expense growth scenarios are plotted in Exhibits 1 and 2, including a more robust 10% growth trajectory (green line) and a weaker 2% growth trajectory (red line).
Exhibit 1: Apple Dividend Expense Trajectory ($ billions)
Exhibit 2: Apple Quarterly Cash Dividend Trajectory (Per Share)
Assuming Apple increases its dividend expense by 5% each year and the current pace of share buyback is maintained, we now have five years of expected dividend expense:
- 2016E: $12.2B
- 2017E: $12.8B
- 2018E: $13.4B
- 2019E: $14.1B
- 2020E: $14.8B
Converting these totals into quarterly dividends per share (keeping in mind share buyback will lower the share count as time goes on), we arrive at:
- 2016E: $0.58
- 2017E: $0.63
- 2018E: $0.69
- 2019E: $0.75
- 2020E: $0.82
This would suggest that when Apple announces a dividend increase later this month, my expectation is for a 12% increase to $0.58 per share per quarter. When converting these quarterly dividends into annual totals, we get:
- 2016E: $2.20
- 2017E: $2.42
- 2018E: $2.64
- 2019E: $2.88
- 2020E: $3.14
Trajectory Shifts
Of course, a company's dividend strategy does not operate in a vacuum. If the business environment changes, management will need to reassess whether or not the change will result in a permanent increase or decrease in industry attractiveness and profitability. A weaker outlook may lead management to cut its dividend growth trajectory in order to conserve operating income. Vice versa, a stronger outlook could give management room to increase its dividend which would benefit current shareholders, including Apple employees.
This is where we can use Apple's likely dividend growth trajectory to our advantage by monitoring whether or not management veers off its current course (blue line). Exhibit 3 highlights how a shift in dividend growth can be either classified as a positive trend (green shaded area) or negative trend (red shaded area).
As an example, if Apple reports dividend expense between $12.8 and $14.0 billion in FY2017, then it would fall in the green positive trend area and indicate that Apple management has increased its dividend expectations. If dividend expense is between $12.0 and $12.8 billion, then Apple reduced its dividend expectations. Apple could certainly report dividend expense that is above and below even the shaded regions, which would obviously indicate somewhat major shifts in management attitudes toward Apple's prospects.
Exhibit 3: Apple Dividend Expense Trajectories
Dividends Matter
Wall Street understands that Apple's earnings are volatile. It is rational to assume that over time, there will be earnings peaks and troughs depending on Apple's current product line at any given moment. Given this volatility, Apple's dividend strategy is aimed at adding a bit of continuity and predictability to the mix. This is just another reason why it is in Apple's best interest to maintain a steady dividend growth rate that can survive the ups and downs of Apple's product line.
While paying a small $0.58 per share quarterly dividend may not seem like a big deal, if Apple grows its dividend expense by 5% each year and continues to buy back shares, Apple will pay nearly $3.15 of dividends per share annually by 2020. At Apple's current stock price, this would equate to a very attractive 2.8% dividend yield. If we assume Apple maintains its current 1.9% yield, Apple's stock price would trade at $165 per share. These two examples show the power behind a dividend, even if it experiences modest growth from year to year. Apple dividends are going to matter much more than many people think.
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