Apple Inc. (AAPL): Reviewing One Of Warren Buffett’s New Dividend Stocks

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Apple (AAPL) is a blue chip stock that recently reinstated the dividend. Since becoming a dividend payer again in 2012 (it was suspended from 1996-2011), they have increased the quarterly dividend by 50% from 38 cents per share to 57 cents.

With a relatively low payout ratio, high returns on invested capital, and an extremely valuable consumer brand, Apple looks undervalued at only 13x 2016 earnings. Warren Buffet’s lieutenants certainty agree as Berkshire invested over a billion dollars in the company this year.

However, in a world where technology trends change drastically quickly, should investors count on Apple to deliver sustainable dividend growth?

iPhone 7 Apple AAPL
Image source: Apple

Business Analysis

Apple is a global technology company with a rich history of product innovation. In fiscal year 2015, they generated sales of roughly $234 billion dollars. To put some context around this colossal sales number, it is larger than the GDP of many countries.

In general, the technology industry is a difficult industry to invest in for dividend investors due to the speed at which trends can influence competitive positions.

The same factors that have allowed Apple to be extremely successful could just as easily go against the company if a competitor were to come out with a far superior product or if a new innovation were to displace the iPhone entirely.

Besides paying attention to all the usual important financial ratios, dividend investors need to pay attention to the sustainability of the current margin structure, projected key product growth rates, and Apple’s capital allocation.

Apple operates the business through key product lines including the iPhone (66% of sales), iPad (10%), Mac (11% ), Services (8.5%), and Other Products (4.5%).

Apple generates enviable economics with returns on invested capital significantly above its cost of capital driven by 30%+ operating margins.

Apple Inc. (AAPL)

Source: Simply Safe Dividends

Margins have significantly increased from around 12% in the pre-iPhone years close to a decade ago. In fiscal year 2006, Apple’s main sources of revenue came from the Mac and iPad. Clearly the economics of the business have changed with the introduction of the iPhone.

Apple Inc. (AAPL)

Source: Simply Safe Dividends

Some reports put the gross margins on the iPhone 6 at nearly 70%. This is a huge margin and obviously helped drive up the company-wide margins well into the 30% range.

Furthermore, Apple’s margin is well in excess of estimated Android phone manufacturer (HTC, Sony, LG, Samsung, etc) margins of flat to 10%.

The only reason Apple can generate such a superior economic profile relative to peers has to be  due to brand power, capturing the full economics of the phone (software and hardware), better terms from suppliers, or a superior product. In fact, it is likely that they benefit from all of these factors.

Given the current business mix and way the business has evolved over the past decade, the sustainability of iPhone margins are the key to maintaining the robust operating profile.

Clearly this could change if Apple develops a breakthrough new product or service. After all, few predicted back in the early-to-mid-2000s that smartphone adoption would take off like it did and that Apple would be the one to capture the majority of the value from the market.

Assuming that the business mix remains the same, the key to the sustainability of the current operating profile and future dividend increases is maintaining the iPhone economics.

A current iPhone 6s costs $100 more (roughly 15% higher price point) than a Galaxy S7 despite the Samsung phones having a better display and camera, more storage, and a host of other features.

If people were simply interested in the specification and features, then purchasing the iPhone at a higher price point does not make sense. Instead people buy based on brand and user experience. After all, if the average person is unable to seamlessly navigate all the features, then the features don’t add any value.

Also, the way most iPhones are purchased enables very attractive pricing. In 2015, 76% of US shoppers bought phones through their carrier. This means that there wasn’t the upfront $600+ sticker shock of purchasing the phone. Instead, the phone cost is built into the monthly cell phone bill. This is akin to financing a car rather than paying cash up front.

The most recent data point indicates that the pricing dynamic in the market is still healthy. Apple recently released their new iPhone 7 family, and some versions are at a higher price point.

While growth investors will be paying attention to the latest news on iPhone shipments and product cycles, the number one concern for dividend investors needs to be on the current margin structure. For now it appears that the iPhone economics appear intact.

Dividend Safety Analysis: Apple

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. Apple’s dividend and fundamental data charts can all be seen by clicking here.

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

Apple Inc. (AAPL)

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here.

Apple’s Dividend Safety Score is 95, which indicates that the dividend is not only much safer than the average dividend-paying stock in the market, but actually one of the safest overall.

The strong safety score is driven by relatively low payout ratios, a healthy balance sheet, strong business economics, and low industry cyclicality.

Since initiating the dividend in 2012, Apple’s free cash flow and EPS payout ratios have stayed below 30%. For 2016, they are expected to generate EPS of $8.28 and pay dividends of $2.23 per share. This implies a very comfortable payout ratio of 27% for 2016.

Apple Inc. (AAPL)

Source: Simply Safe Dividends

Apple Inc. (AAPL)

Source: Simply Safe Dividends

Apple’s balance sheet is one of the healthiest in corporate America. As of the end of the second quarter 2016, they have over $18 billion in cash and another $213 billion in short and long-term marketable securities.

These marketable securities are mostly composed of U.S. treasuries, corporate debt, and mortgage and asset-backed securities.

Offsetting this cash and marketable securities is $12.5 billion in commercial paper and a little over $72 billion in current and long-term debt.

Overall, Apple has over $145 billion in net

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