Dividend of the Week

After several years as a stock market darling, Apple (NSQ:APPL) has lost its lustre over the past 12 months. Last week the release of its latest iPhones underwhelmed analysts and the market wiped almost $40 (£25) off the share price. As a result, the shares now sit on a modest rating of just 11.8 times earnings for the year ended September 2013. That falls to 10.7 times 2014 consensus estimates and 9.7 times 2015 analysts' forecasts, according to the Nasdaq website.

The loss of Apple's highly driven founder, Steve Jobs, appears to have coincided with a period in which the company's enviable record of innovation has faltered, which has been reflected in a disappointing reversal in the share price as some critics have argued that Apple has entered a 'post-growth' phase. But even if you accept that argument, Apple still remains a compelling investment case, especially if you look at the potential for long-term dividend growth. For that reason we are going to examine the dividend effect over several different scenarios and try to give readers a long-term perspective on the potential performance of Apple's shares.

I recently wrote an article on a FTSE 250 company called RPS (RPS), which has an enviable track record of 20 years of annual dividend increases at a rate of 15 per cent. But which companies will be able to match this sort of record for many years hence? A number of companies have the potential to match RPS's record but, in my opinion, Apple is the company most likely to achieve it.

First of all, let's take a look at the dividend history of Apple. It only began midway through the 2012 financial year with two dividends of $2.65.

The first quarter of 2013 saw a further payment of $2.65 and the second quarter saw this increased by 15 per cent to $3.05. That was maintained in the third quarter. The number above for 2013 assumes one further payment of $3.05.

If we assume that the standard increase in the dividend is going to be 15 per cent for the foreseeable future, what will happen to Apple's dividend over time? The base is $11.80.

In five years' time: the dividend will rise to $23.73.

In 10 years' time: the dividend will rise to $47.74.

In 20 years' time: the dividend will rise to $193.12.

These are staggering numbers, particularly in the long term. The table below produces a number of scenarios and then we go on to look at how possible it will be for Apple to achieve these scenarios. I believe that the 20-year scenario is well within the realms of possibility.

Given the lack of dividend history, I'm taking the recent rise of 15 per cent as a likely benchmark for near-term increases. How much will this cost Apple?

The base year is 2013 and the base dividend is $11.80. The calculations assume no share buy-backs. Although we know that Apple has committed to share buy-backs of $60bn, it is impossible to calculate the effects upon the balance sheet, earnings per share and how much Apple will pay out in dividends against a diminishing number of shares without knowing details of the buy-back.

Let's run the 20-year scenario:

To give some idea of how easily Apple can afford to pay these dividends, it will take until 2024 before the dividend payout even equals the free cash flow Apple generated in the 2012 financial year. Add to that Apple's $146.6bn cash mountain and we can reasonably assume Apple can grow its dividend at 15 per cent for a long time to come. Apple has strong dividend cover of 3.65 times as well as the most cash-rich balance sheet in the world.

What are the threats to this scenario?

Apple has been accused of a lack of innovation. There is talk of Apple TV and an Apple iWatch, but nothing has been seen yet. These are big markets, but rivals are catching up fast and in some cases getting ahead - Samsung's smartwatch launched earlier this month.

But Apple is rumoured to be hanging a lot on the iWatch project. Rumour has it that Apple has a team of around 100 designers, software engineers, managers and marketing executives working on "a wristwatch-like device that may perform some of the tasks now handled by the iPhone and iPad".

British designer Sir Jonathan Ive, accredited with the iPhone and the iPad, is said to be leading the drive towards the ultimate watch. As yet, the release date and price are unknown. Industry rumours have suggested a 2013 release date. This is uncertain, but it will almost certainly be no later than 2014. Analysts have calculated that if 10 per cent of iPhone customers buy an iWatch, at $250 a pop, Apple is looking at $7bn a year in revenues.

The wearable watch market could be the next big tech battleground as major competitor Samsung has already launched the Samsung Gear smartwatch, retailing at around £299 in the UK, which allows users to check emails, make calls and connect to the web. Google is also reported to have filed a patent for a smartwatch as has LG and Sony's Smartwatch 2 launched in June.

It is not unusual for Apple to let the competition forge slightly ahead. The company watches and learns and then brings out the 'slam dunk' product.

Apple's recent history

So what about the numbers? Apple's historic figures are as follows:

When Apple's shares breached $700, some market watchers talked of them hitting the $1,000 mark. But all that changed very quickly as the shares slipped below the $400 level. They currently sit at $465, having taken a battering over the past few days as the market reacted badly to its new iPhone variants.

In conclusion, Apple's stock is cheap whichever way you look at it. It is on an undemanding multiple and the most recent trading numbers show the ongoing resilience of key products such as the iPhone, which achieved record sales for the June quarter. All of this is underscored by an extremely powerful balance sheet and very robust cash flows, which will lead to ongoing returns to shareholders in the form of share buy-backs and dividend payments.

If you strip out the cash from the market capitalisation, the earnings multiple falls dramatically. Effectively, around 36 per cent of Apple's market capitalisation is cash.

As a final pointer, renowned US investor Carl Icahn was buying in recent days, as he relayed in this messages on Twitter last Wednesday: "We currently have a large position in Apple. We believe the company to be extremely undervalued. Spoke to Tim Cook today. More to come."

If you are buying Apple for the long term, ensure that you fill out the relevant forms to reclaim half of the 30 per cent withholding tax that the US charges overseas investors.