Dividend?

On March 19, Apple announced a stock buyback and dividend program totaling $45 billion over the next three years. $10 billion would be used for a stock buyback program and the remaining would be paid out in dividends of $2.65 per share each quarter. With Apple’s 930 million shares, this means that Apple is committing to a dividend of about $10 billion per year for the next three years (and most likely beyond). This is Apple’s first dividend in 15 years. So why would Apple decide this is the right approach now?

A while back, we wrote about stock buybacks, so we won’t spend too much time on them. Overall, they are a good idea when you think your stock is undervalued and a bad idea when the opposite is true. Of course, management teams typically blow this and buy back stock when it is most expensive. The buyback is at least a signal to the market that Apple’s management team still believes the stock to be underpriced. Apple’s stock price is currently floating at all-time highs, but many experts, including Professor Damodaran, still see the stock price as undervalued, so it is tough to tell whether the timing on this is great or not.

We think the bigger question here is why this is the right time for Apple to start the dividend program?  Doesn’t Apple have a better use of its cash than to give it back to shareholders? They certainly have done a great job of generating returns in the past, producing a return on equity of more than 25% and close to 60% growth in net income in each of the last two years. The only way to continue generating this type of growth is to invest back in the business. However, Apple is choosing not to do this. Instead, the return of cash to shareholders is signaling that it believes it does not have the growth opportunities available to require all of its cash.

Now, please don’t take this signal as Apple being in a bad place. It currently has approximately $100 billion in cash on its balance sheet. $100 billion is so much money that you can’t start individual projects with it, you can only buy companies (large companies, like say Facebook and then still have some cash left over). So we don’t blame Apple for their decision. Apple is one of the very few high P/E technology companies that are already generating vast amounts of cash. They have almost no debt. The issue is more a testament to the laws of large numbers and the limits to growth in large companies than anything else.

Just a small diatribe on size: we can’t tell you how many articles we’ve read in the past few months stating that Apple is the world’s largest company. This is false. Apple is the largest company by market capitalization (meaning the market value of equity). Which company is the world’s largest really depends on how you measure it (whether by enterprise value, enterprise value plus cash, or total assets), but the title belongs to Exxon Mobile, GE, or JP Morgan (depending if you include financials and if you include GE as a financial company). Exxon’s capital structure does not materially change its overall value. This is a great example of why it is so necessary to think through things you read, even in The Wall Street Journal or the Financial Times. They are often directionally correct but factually mistaken, so it is important that you examine everything you read and try to process it yourself.

Still, is $10 billion in dividends sufficient to use all of Apple’s “excess” cash? After paying the dividend and buying back shares, Apple is still expected to generate $30bn per year in cash. By 2015 they will have almost $200 billion in cash on their balance sheet. This may be a great problem to have, but investors must be wondering what the plans are for the rest of their money.