Apple Does Not Need its Cash to Grow as Much as its Shareholders Need it to Spend
Learning From The Past
With all the media attention, most everybody is now aware that Apple (AAPL) has decided to use their prodigious cash hoard by initiating a stock buyback and dividend for the first time in their history. Regarding the stock buyback, their announcement indicates that they would share their cash holdings by buying back shares over the next three years. According to company statements, the primary objective of their share buyback program is to offset the impact of employee stock options and equity grants. Regarding the dividend, they announced a $2.65 quarterly payment starting in July of this year which represents a current yield of approximately 1.8%.
At this stage of the game, it remains uncertain as to whether Apple (AAPL) will continue to pay this dividend on a permanent basis, or that, as they indicated with their stock buyback program, only pay a dividend on a temporary basis. Assuming that CEO Tim Cook is correct in stating that Apple (AAPL) does not need all of its cash hoard, and/or annual cash flow generation to run the business, the more permanent dividend policy maybe the logical outcome.
The following historical F.A.S.T. Graphs™ looks at Apple from the perspective of price correlated to earnings. Note that the light blue shaded area at the end of the graph indicates the recent dividend announcement. We are showing two quarters of dividends for 2012 followed by four total dividend payments for 2012 (assuming two quarters at $2.65) a $5.30. However, since Apple is currently not paying a dividend, and will not until July, we are not showing the current yield to the right of the graph at this time.
With our next historical F.A.S.T. Graphs™, we are looking at Apple from the perspective of price and free cash flow only. The definition of free cash flow used to draw the following graph is as follows: This concept is Operating Activities minus Net Cash Flow minus Cash Dividends minus Capital Expenditures. This is divided by Common Shares Outstanding. Of course, there have been no dividends subtracted out of this mnemonic as of yet. On the other hand, the graph clearly validates CEO Tim Cook's position that the company does not need all of its free cash flow generation in order to run the business.
With our next historical F.A.S.T. Graphs™ we look at Apple from the perspective of earnings, price and dividends as we did with our first graph. However, we have now added cash flow per share which is defined as follows: This concept is Cash Flow divided by Common Shares Outstanding. What is most astounding about this particular graphic is how closely cash flow and earnings correlate with each other.
With our final historical F.A.S.T. Graphs™, we reviewed Apple from the context of price, earnings and dividends correlated with Operating Activities minus Net Cash Flow. This cash flow mnemonic is defined as follows: This mnemonic represents the net change in Cash from all items classified in the Operating Activities section on a Statement of Cash Flows. This item includes changes in operating assets and liabilities. Increases in cash are presented as positive numbers. Decreases appear as negative numbers.
(Follow this link to a free, live, and fully functioning F.A.S.T. Graphs™ on Apple. Run this "tool to think with" through its paces. Draw graphs displaying 2 to 20 years of history. Discover how this tool dynamically re-evaluates valuation based on the company's earnings and price relationship.)
Looking to the Future
The following earnings and return calculator graph, followed by the earnings yield estimator table looks at Apple's potential going forward. With these two forward-looking F.A.S.T. Graphs™ tools, we can run some estimates and forecasts of what Apple's future dividend policy might bring. For conservative purposes, we have held the current dividend announcement level at $10.60 over the next three years. This is only speculation on our part, assuming that Apple is looking at dividends the same way they are looking at stock buybacks.
The estimated earnings and return calculator is based on 36 analysts as reported to Capital IQ who expect Apple will grow their earnings at the rate of 19.5% over the next five years. The reader should note that this is materially less than the more than 60% per annum growth that the company has achieved over the past 5+ years. Consequently, it's at least possible that Apple will continue to grow faster than what the analysts are currently forecasting.
The 10-year earnings yield estimates table should be used in conjunction with the above estimated earnings and return calculator. However, since this table was designed to compare earnings and dividends to the riskless return available from the 10-year Treasury bond, it extends out all the way to calendar year 2021. This table provides a hypothetical estimate of the potential growth yield (yield on cost) that the new dividend growth stock Apple may offer prospective investors.
Summary & Conclusions
Apple (AAPL) has been one of the most powerful growth stories in the world since Steve Jobs returned to the company in 1997. As you can see from the historical F.A.S.T. Graphs™ above, it took Steve a few years to get the company growing again. However, once his ideas took hold, earnings growth has been nothing short of spectacular. Only time will tell if Tim Cook is capable of filling his big shoes. Apple's decision to use their cash hoard to buy back stock and pay dividends is in stark contrast to Steve Jobs' views. However, no one can really say whether or not Steve would have agreed to and supported these latest moves, in light of the clamor and pressure that investors were placing on the firm.
Nevertheless, it seems clear that Apple will continue to be a strong growth story into the foreseeable future. How long that will happen, only time will tell. For additional insights into my feelings on Apple after Steve Jobs' untimely passing can be found by following this link to an article I published in October of 2011. Although it is somewhat odd to think of Apple the dividend growth stock instead of Apple the consummate pure growth stock, the dividend income is most appreciated. Like many other investors, I do not believe that Apple needs all of their powerful cash flow generation to fund future growth. Therefore, sharing their cash with shareholders is a most welcome occurrence. Nevertheless, I continue to believe that Apple represents an extremely undervalued technology holding that now offers an attractive, and hopefully growing, dividend income stream.
Disclosure: Long AAPL at the time of writing.