Bloggers, market gurus, journalists and day-traders all seem to have strong opinions as to whether Apple (AAPL) should pay a dividend.
On one side of the argument, the “Apple-istas” strongly defend management’s decision to snub shareholders. Apple’s return on equity was 45.6% last quarter.
At this rate, the book market value of $1 re-invested in Apple more than doubles every two years. Why would any sound investor take cash away from this money machine? Apple will use this cash to launch the next wave of revolutionary products, from the iPhone 5 to the iPad 3.
No other tech company has such an exciting line-up of products. After 12 years of net market losses for US equities and amidst record low bond yields, Apple’s balance sheet clearly gives you the best bang for the buck.
On the other side of the argument, value-minded investors argue that Apple is sitting on more cash than it can handle. Apple has a treasure chest of about $30 billion in cash, short-term investments and marketable securities. This pile of cash has been fairly stable over the past few quarters, suggesting that the cash is just sitting idle rather than being used for the business.
When people buy shares of Apple, they are really investing in two companies: the greatest technology venture in the world and a very low-yielding money market fund. Why not return the cash and let investors decide if they want to buy short-term Treasuries with it?
The other problem with carrying too much cash is that such a huge pile of cash excites the gluttony of investment banking sirens. Apple could be tempted into overpaying for stupid acquisitions. For example, $30 billion in cash will buy you almost all of Hewlett Packard (HPC), 1.5 Nokias (NOK) or about 6 Research in Motions (RIMM)!
My impression is that Apple does not feel it needs to pay a dividend. It has become the world’s most valuable company without ever paying a penny in dividends --- quite an accomplishment when financial theory tells us that the value of the company is the net present value of its dividend stream!
Paying dividends is good for old boring companies such as Microsoft (MSFT), Intel (INTC) and Procter and Gamble (PG). Apple is too cool for that. Paying a dividend would signal that Apple can no longer find better investment opportunities than the average Joe, quite an insult for the management team.
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Here is my suggestion: how about a buyback? Contrary to dividends, buybacks are rarely seen as signaling a lack of growth opportunity. Rather, the market treats them as a signal that management believes that its stock is underpriced.
Contrary to dividends, buybacks can be scaled back easily if Apple needs to save cash for its own investments or acquisitions. Dividend cuts are lived like personal tragedies for income investors. Barely anybody notices decisions to cut or cancel buybacks.
Buybacks have the same practical effects as dividends: they transfer cash from the balance sheet of companies to the pocket of investors. But they have much more favorable tax impact, due to the lower tax rate on long-term capital gains.
There is another reason for Apple to start its buyback program: Apple has been overly generous with stock options. Apple’s outstanding shares have grown from about 700 million in 2003 to 930 million at the end of 2011. Every year, shareholders’ stake in Apple’s earnings and assets gets diluted by 10 to 15%.
Few investors currently complain because this dilution is dwarfed by capital gains of 520% in the past three years alone. But dilution works like the relentless action of waves, slowly but surely eroding the value of stocks.
I can only think of one reason why Apple’s management has not announced a large buyback program: it believes its shares are overpriced and is waiting for a pullback in the stock price to pull the trigger.
