Companies pay dividends to create as much shareholder value as possible. Most profitable companies simply cannot successfully reinvest all of their income into building their business. They operate in certain niches, and can allocate capital to grow strategically. The first dollars tend to provide decent returns, but adding more and more money typically results in further dollars being less useful, so a lot of capital is wasted when it could have been sent to shareholders.
Here’s a link to a video about dividends on Morningstar. Josh peters, author of The Ultimate Dividend Playbook and editor of Morningstar’s DividendInvestor newsletter, discusses low-yield companies and what his expectations are for the future of dividends.
It’s a useful video where Peters discusses dividend payments of tech companies, tax implications of dividends, and his overall insights into where dividends fit into the investing picture.
Mentioned in the video is Berkshire and its blatant lack of a dividend. Buffett obviously loves dividend companies, since a large part of his company’s portfolio consists of dividend payers, and all of his fully-owned companies are essentially dividend paying companies, and yet his company does not pay dividends. Peters argues that Berkshire may be a sole exception to the dividend rule, since Berkshire is a conglomerate and Buffett can successfully allocate the capital in so many areas.
The name that suck out in my mind, however, was Apple (AAPL).
A company’s free cash flow is a good metric to look at. Free cash flow is equal to cash flow from operations minus capital expenditures. Successful companies tend to have high free cash flow because their businesses are profitable enough to keep pulling in cash without requiring much capital expenditure to maintain or grow.
Apple is an unmistakable example of this type of company. The year 2009 saw Apple pull in over $9 billion in free cash flow with no sign of that strength fading. And the company has over $24 billion in cash and cash-equivalents just sitting on its balance sheet. It’s barely making acquisitions and it’s capital expenditures are low, yet has a huge market capitalization and exceptional growth.
I think Apple is due for a dividend. But I guess shareholders don’t seem to think so.
Should they follow the path of Microsoft and pay a large special dividend to clear out their balance sheet a bit, and then institute a reasonable dividend policy? Or no? What about Berkshire Hathaway? Let me know what you think with a comment below.
Cisco is paying a dividend next year, so Apple should pay one too.
In response to your question, it depends on what you are looking for as a shareholder. I assume that most APPL shareholders are growth type investors so a cash or special dividend would be taxable in their hands and they would need to re-invest these funds. But APPL can use the dividend funds to attain additional shareholder value greater than giving it back to the shareholders, then investors would be happy. Perhaps APPL should look at buying back their shares to enhance share value. Without reviewing their financials in great details, I would caution that APPL is a tech company and thus needs large amounts of R+D funds to keep on producing new innovative products.
I agree that Apple should pay a dividend. In the video, Peters mentioned that it’s his feeling that every company with sufficient free cash flow should be paying dividends.
Thank you for your comment.
The point about mentioning free cash flow is to show that Apple does not need that money to grow. Apple pulls in billions of dollars in free cash flow, which is cash AFTER expenses like research and development. Their main drivers of growth are effective innovation and marketing rather than things that involve large capital expenditures. The company paid over $1 billion in 2009 for research and development, which is large in absolute terms, but small in relative terms to how much money they pulled in.
If Apple was able to attain greater shareholder value by not paying dividends, then it might be excusable. But currently, Apple’s money is just sitting in very low-yielding short-term investments. They’re not using the money. Apple could be having all of this growth while also paying dividends.
I would say no way. Apple may have a hige market cap but the company is still in full growth mode. Until Apple stops bringing home 20% plus returns for shareholders, the company should keep reinvesting earnings in product development.
Good question and hard to answer. There is a negative taint if they do though, b/c people will then think it’s too big to reinvest and grow. Law of large numbers says they can’t grow at this pace forever… or can they?!
I agree that Apple might tarnish their stock reputation by paying a dividend. A lot of tech companies shun dividends. It’s an excuse for not being as shareholder friendly as it could be. Luckily for Apple, their growth has been astounding so no shareholder in their right mind would complain.
The thing is, though, they could pay a dividend without sacrificing any current growth, based on their free cash flow. Apple has been an exceptional business, attaining growth without much relative capital expenditure. At the current valuation of Apple stock, share buybacks might not even be such a bad idea and would have less of a stigma attached.
The thing is, that Apple is not reinvesting most of its money in product development. It’s growing without reinvesting much. Most of the money just sits on the balance sheet in low-yielding cash-equivalent investments.
It’s a compliment to Apple to show that they’re growing so well without large capital expenditures. This is common among high-quality, established tech companies. But if they’re not spending their money on growth, what are they spending it on? In Apple’s case, the answer is nothing.
In the last two years, Apple’s stock price has tripled. If you want to own stock in a company that pays a great dividend, buy Altria (MO). Their share price increased 150% in the last two years. Some other high dividend stocks did not fare nearly as well, by the way.
Repeat after me: I cannot have everything. I cannot have everything.
Thanks for the comment.
I want to clarify that, as a company, I like Apple. I’ve even considered investing in it, and it’s still on my watch list. There’s no doubt that it’s done exceptionally well for shareholders.
Back in April, I published an article that mentioned Apple, and described it as the best value of a bunch of highly valued stocks. Since April, its stock has increased by nearly 20%, which is the second most out of the bunch (Netflix ended up skyrocketing).
How to Deal with Highly Valued Stocks
And I still think Apple is a good value.
But I think it’s important to realize that, in some cases, you CAN have everything. If Apple had to trade growth for dividends, then my thoughts on a dividend would be “absolutely not”. But it doesn’t. Apple has a tremendous amount of free cash flow, which means they have all this extra cash sitting around AFTER they’ve already invested money for growth.
Look at their income and cash flow statements. In 2009, Apple spent less than 15% of their gross profit on research and development. More went to general/administrative expenses. Left over was billions of free cash flow, and it was used to buy short-term cash-equivalent securities with a terrible rate of return.
I think a problem is that a lot of tech companies, and perhaps a lot of investors, look at dividends as an “either/or”. You either grow, or you pay a dividend, but not both. But that’s a myth. Many successful companies (and Apple would be near the top of the list) generate a tremendous amount of cash; FAR more than they need to reinvest. Some companies waste it. Apple just lets it accumulate on the balance sheet (which admittedly is better than wasting it). This represents cash that is not driving Apple’s growth. It’s in addition to Apple’s growth. Apple could have exactly the same growth rate by doing exactly the same things they’re doing now, while also paying a dividend.
By the way, I appreciate the discussion. I’m interested to see opinions, especially from people passionate about investing and personal finance, and/or from Apple shareholders.
Thanks for the thoughtful response, Matt. What do you suppose Apple has in mind for its $24 billion? Remember, Steve thinks big :-)
If only I could read the mind of Steve Jobs. :)
Honestly, though, I don’t think he has anything in particular in mind.
Business Week Article
“Feb. 25 (Bloomberg) — Apple Inc. Chief Executive Officer Steve Jobs said he prefers holding on to the company’s cash hoard for potential acquisitions and “bold” investments, rather than paying dividends or buying back stock.”
“We know if we need to acquire something — a piece of the puzzle to make something big and bold — we can write a check for it and not borrow a lot of money and put our whole company at risk,” Jobs said today at Apple’s shareholder meeting. “The cash in the bank gives us tremendous security and flexibility.”
He’s just playing it safe. I agree that Apple would do well to keep an exceptionally strong balance sheet, but $25 billion in cash is pushing it. It’ll be interesting to see if he ever puts that money to good use in the next year or so, but over the past several years, he’s just been letting it accumulate.
Khaleef @ KNS Financial
I believe that they are on the lookout for a couple of large acquisitions (purely my speculation). I honestly would be a little upset to own a company with about $25 billion in cash just sitting there, rather than increasing shareholder value through buybacks and dividends!