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Apple the World's Largest Company? Yes. Maybe. Sort of.

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Congratulations, Apple (Nasdaq: AAPL  ) .

After reporting an astounding quarter on Tuesday, the tech giant's shares surged enough to surpass ExxonMobil (NYSE: XOM  ) as the largest publicly traded company on Earth based on market capitalization. As I write, Apple and Exxon are now both worth around $416 billion, with Apple ahead by a few hairs.

But hold on -- there's a difference between the two. Exxon paid out $131 billion in dividends over the last 20 years. Apple has paid a trivial sum, and ceased paying dividends entirely in 1996. While Exxon writes shareholders checks every quarter, Apple keeps cash in the bank, pushing its market capitalization up by default. If Exxon had been equally as stingy with its dividend policy, it would be the larger company today by far.

Another way to look at it: After subtracting cash and cash equivalents, Exxon's business is worth around $405 billion; Apple's, about $315 billion.

These calculations are somewhat meaningless. Apple does have a larger market cap. But thinking about a company's value in these weird, abstract terms brings up a very real and important topic: the role dividends play in accruing value to shareholders.

I'm an unapologetic cheerleader of companies that pay large dividends because the historic evidence is, in my view, unambiguous: Companies that pay higher dividends produce greater returns than those that do not.

Recently, Fool colleague Chris Baines took issue with this stance. Using the same logic I outlined comparing Apple to Exxon above, Chris noted that whether a company pays a dividend or not is technically meaningless, since cash not paid to investors increases shareholder equity and pushes a company's market capitalization up. He wrote:

As a shareholder, it's your cash regardless of whether it's given to you in higher shareholders' equity per share (which increases the share price $1 for $1) or a cash dividend. You can always sell shares to create a dividend in whatever amount you wish.

There's a name for this, Chris points out: The Modigliani-Miller capital structure irrelevance theorem. "According to Modigliani and Miller," he wrote, "there's no wrong answer in a perfect and efficient capital market. ... Your choice is irrelevant."

Chris took another shot more recently:

Morgan claims that dividend payers have historically outperformed nondividend payers. This is absolutely true. ... What I dispute is that these companies outperformed because they paid dividends, and that therefore managements are putting their shareholders in "peril" by not paying more in dividends. Morgan's academic studies prove that dividend payouts and outperformance are correlated, not that dividend payouts cause outperformance.

But that's not quite right. The studies do, in fact, show causation -- that companies that pay higher dividends produce greater returns because they pay higher dividends.

The issue here is what a company's management does with cash that isn't paid out as dividends. If used efficiently for well-timed share buybacks or smart acquisitions, retaining cash can be a wonderful thing.

Some companies do this well. Most, however, don't. And as investor Rob Arnott has pointed out (link opens PDF), that renders some of Modigliani and Miller's assumptions dubious:

Implicit in this view is a world of perfect capital markets. For instance, this reasoning assumes that investment policy is unaltered by the amount of dividends paid, that information is equal and shared (meaning the dividend does not convey managers' private information), that tax treatment is the same for retained or distributed earnings, that managers act in the best interests of the shareholders, that markets are priced efficiently, and so forth. When the assumption of perfection is relaxed, a host of behavioral or information-based hypotheses arise as potential explanations for how the market's payout ratio might relate to expected future earnings growth.

Chris gives this point some attention. "In the real world, companies look at taxes, transaction costs, and other factors as they come up with an optimal capital structure," he writes. But he then dismisses its importance: "Such tweaking may allow a company to benefit from such frictions. But you certainly won't be able to retire on it."

Arnott shows, however, that dividend policy is vitally important to a company's returns. Counterintuitively, low dividend payouts are associated with low future earnings growth expectations, and vice versa. Why? Because companies that retain earnings rather than pay them out as dividends are habitually tempted to engage in "inefficient empire building and the funding of less-than-ideal projects and investments, leading to poor subsequent growth, whereas high payout ratios lead to more carefully chosen projects," Arnott writes. And the market knows it.

This may not seem applicable to Apple, since management isn't using a significant amount of retained cash to invest (yet). But that doesn't mean cash held on its balance sheet creates the same value as a dividend paid to shareholders.

Chris writes that cash held on the balance sheet "increases the share price $1 for $1." But it almost certainly does not. Cash held on a balance sheet is often discounted by the market. And for good reason: As Arnott's data show, there's an uncomfortably high probability that a company will squander its cash on poor investments.

Chris writes, "According to M&M, there is no harm in [hoarding cash] as long as the cash is invested in something with returns commensurate with the risk." The problem is, much of it eventually is not. With the exception of a small number of companies that have exceptional track records of investing retained earnings, a dollar in shareholders' pockets is worth more than a dollar a company holds in the bank and promises to look after for you. This alone likely explains why Apple trades at a fairly low P/E ratio, particularly since it has no real track record of making mega-acquisitions.

Back to the original point: Is Apple the world's largest publically traded company? Yes. But it could potentially be worth so much more if opened up to the possibility of dividends. When -- or if -- that will happen, don't hold your breath. As Chief Financial Officer Peter Oppenheimer said on a conference call this week, "We're not letting [the cash] burn a hole in our pockets."

Fool contributor Morgan Housel owns shares of ExxonMobil. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Apple. Motley Fool newsletter services have also recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (24) | Recommend This Article (42)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 26, 2012, at 4:09 PM, Hawmps wrote:

    This is great... I love to read oposing views on various topics from you guys. You go about it very professionally and both pose strong arguuments.

    I for one lean more toward your arguement, Morgan, that a dividend policy can add to shareholder value. Every time a dividend is paid to a shareholder, more demand is created for that stock, because it paid a dividend and a dividend policy will have an affect on an investor's investment decsions. Perhaps mathmatically, in a perfect world, holding cash versus paying it out should "increases the share price $1 for $1", but as you point out, capital markets are not perfect nor are they priced efficiently. Cash held on the balance sheet should be discounted (at least slightly) by the investor for risk; risk that the one's controllng the cash will make sound investment descisions with said cash and not piss it away.

  • Report this Comment On January 26, 2012, at 4:13 PM, jdwelch62 wrote:

    Show me the dividends!!!

    When it comes to either me getting dividends and investing them myself, for my purposes and goals, or the company holding the cash for me to invest as they see fit, I'll take my chances with my choices every time!

    Also, I think paying a healthy dividend would go a long way towards securing Apple's per-share price, in that more investors will be willing to hold onto share if they're yielding a regular and safe dividend. Since I'm not so sure Apple can continue innovating without Steve Jobs beyond a 3-to-5 year window, implementing a dividend might be a good strategy for Tim Cook to use to help ensure shareholder loyalty...

  • Report this Comment On January 26, 2012, at 4:20 PM, luxetlibertas wrote:

    Apple is a fascinating company.

    Steve Jobs surely has thought a lot about what might be done with the cash, although at the moment the amount is piling up even faster than he dared imagine.

    My guess is that at Apple they now have the ambition to create groundbreaking product after groundbreaking product. That's fun, and that's where they live for. They have the means to advance any technology they need to create the devices that they dream up. They have the vision. They have the experience to judge what ambitions are within reach. And they have the focus and discipline to actually make it work.

    And if that's where the cash is going, I couldn't be happier.

  • Report this Comment On January 26, 2012, at 4:33 PM, Hawmps wrote:

    luxetlibertas > you make some good points and perhaps Apple is an exception, but still, cash in my pocket any day of the week... oh yeah, since it is the end of the month, cash in my pocket every day up until Tuesday then it starts all over agian for my holdings that pay out quarterly divs in February. For me, a balanced portfolio includes dividends that get thrown my way from a few different directions every month... build my own lil' hoard of cash, and buy on an earnings miss.

  • Report this Comment On January 26, 2012, at 4:35 PM, jdwelch62 wrote:


    Really? Apple needs that big of an R&D budget to "advance any technology they need to create the devices that they dream up"? Intel spends quite a bit on R&D, and according to their latest earnings report, plan on spending a whopping $10.1Billion in 2012. Is the R&D required to conceive, design and develop consumer electronics products as high as semiconductor technology? I don't think so! Apple can certainly take some of that cash horde and implement a dividend, given their current and projectect cash flow, they'll still accumulate more than they pay out, even with a generous dividend...

    (BTW, you speak of Steve Jobs in the present tense. in case you hadn't heard, he's DEAD...)

    Fool on!... :-)

  • Report this Comment On January 26, 2012, at 4:38 PM, jdwelch62 wrote:



  • Report this Comment On January 26, 2012, at 4:49 PM, lucasmonger wrote:

    If you invested in Apple stock during the dot-bomb era ($6.50 per share.. adjusted for the stock split) you would care less about the dividend as the current stock price more than makes up for the lack of dividend paid out during that time.

    As for being having the largest market cap in the world... this certainly makes Michael Dell eat crow with his suggesting that Apple return money to their shareholders and shut down the company.... or Steve Balmer scoffing at the $600 original iPhone and exclaiming that Microsoft had a strong mobile offering.

  • Report this Comment On January 26, 2012, at 5:17 PM, PaulChristenson wrote:

    The other difference between APPL and XOM is that a lot of APPL's potentially non-replaceable assets walk out the door every night and may decide to start up their own company at some point...

  • Report this Comment On January 26, 2012, at 5:33 PM, TheDumbMoney wrote:

    Three points:

    1) truth is right in his comment;

    2) Anytime someone talks to me of "a perfect and efficient ... market" I am...amused;

    3) if Apple had to repatriate its $64 billion in foreign cash, it would have to pay 35% income tax and that would lop off 5% of it's market value, so it's not really worth more than XOM anyway.


  • Report this Comment On January 26, 2012, at 5:36 PM, luxetlibertas wrote:

    @jdwelch62: Steve Jobs lives on in Apple, for the next 10 years anyway ;-)

    I agree that I cannot think of a project of the kind Apple likes to do that would require more than a few billion. The cash probably is a distraction for them, and it is quite possible that Apple will start a dividend, even as soon as this year.

    But the official line always was, that they value highly the flexibility of an essentially unlimited amount of cash at hand, that they expect future opportunities to come along that can only be captured if they have that flexibility. Any bank you involve will leak info, and you will inevitably read all too soon about your own plans in the Financial Times (after the City has cashed in on the info of course). The thought of what kind of opportunities there could be is intriguing of course...

    My point is, that Apple is now in an unique position to deliver the tech of the future (and hopefully not ultimately in a dystopian way...).

    The question of whether, and how long, they can continue to do their thing in a successful way eclipses in importance any other consideration I think.

  • Report this Comment On January 26, 2012, at 6:23 PM, thekwan wrote:

    Wow! M&M, dividends, market cap. Can someone please tell me what the point is here? If Exxon didn't pay the dividends and we simply add back the cash, well I guess it's market cap might be bigger. Ceteris paribus. But all things do not remain equal. And quite frankly, I really don't care. Apple has created more shareholder wealth over the last 10 years than Exxon. Am I wrong and isn't that the only thing that matters?

  • Report this Comment On January 26, 2012, at 6:27 PM, cmfhousel wrote:

    <<Am I wrong and isn't that the only thing that matters?>>

    No, and that is the only thing that matters. But as the article states: "Is Apple the world's largest publically traded company? Yes. But it could potentially be worth so much more if opened up to the possibility of dividends."

    Thanks for reading.

  • Report this Comment On January 26, 2012, at 6:54 PM, ac22 wrote:

    I agree that bird in my hands is worth more than a unfilled promise. CEO's that hoard cash, have tendency to waste it on projects and mergers. My wife does overspend when the money is rolling in but has a different attitude when I got laid off work.

    Efficient market or inefficient is academic bull manure. Who buys or sells stock based on efficiency analysis of the market? Does ones 401 money manger really do such? Do any mutual fund managers really do such? I doubt it.

    My question is; what do these cash hoarders do with their cash? Is it in the bank earning 1.0% more or less per year? 5 year treasury is at less than 2% yield. Hummmm!!!

  • Report this Comment On January 27, 2012, at 12:27 AM, lowmaple wrote:

    We the Fools agree diversification is important.So I argue that if apple paid a dividend we could reinvest (andmake even more money) or we could use that cash and diversify into other very good companies and not have to worry as much about whether apple squanders that cash someday.

  • Report this Comment On January 27, 2012, at 2:55 AM, TEBuddy wrote:

    theKwan, you may have made more returns, but at what risk, that the next iPhone or iPod isnt good enough, that in 3 years it could potentially be non-existent, irrelevant. AAPL almost died once, and it can happen very easily again. All tech giants rise, get fat and fall. Its a predictable pattern, unless Apple is the one that survives the apocolypse and arises as a new world order. Meanwhile XOM has a long history of solid performance, pretty much no risk that youre going to make some money since theres a dividend and their volatility is low. Someone with the foresight to buy AAPL shares at $7 and hold them until now would be rich if they sold today. But the same could be said about a lot of startups that made it big.

  • Report this Comment On January 27, 2012, at 3:23 AM, EdGrey wrote:

    It makes more sense for some companies to distribute dividends than it does for others. Some companies are good at plowing earnings back into something that is likely a better investment than the shareholder could find elsewhere. A prime non-tech example is Berkshire Hathaway.

    If a company is already at "full size" or "too large," or if management doesn't know what to do with the extra cash, then it makes sense to pay a dividend.

    Also, dividends are taxed at a higher rate than capital gains. (Or is that only for long-term capital gains?)

  • Report this Comment On January 27, 2012, at 9:02 AM, luxetlibertas wrote:

    Here's one idea that I find appealing.

    Apple is already big in e-commerce and processes billions of, mostly small, payments. The credit card companies take a significant amount of money there, and their image is pretty bad (maybe an understatement...).

    If Apple is able to preempt privacy concerns and offer better service and conditions, they could add a *major* profit center to their business. Without departing very far from their current strengths.

  • Report this Comment On January 27, 2012, at 4:16 PM, TheDumbMoney wrote:

    Excellent article, by the way.

  • Report this Comment On January 28, 2012, at 12:10 AM, cbaines2 wrote:

    Morgan, you actually agree with just don't know it yet. ;-)

    For those who say "They'll squander it", I recommend reading the articles of mine Morgan has so kindly linked to. The short answer is a company doesn't need retained earnings to raise and waste cash...they can issue equity. It's the same thing in finance, just like share buybacks and dividends are the same thing.

    Hawmps - thanks for the praise!


    Chris Baines

  • Report this Comment On January 29, 2012, at 10:54 PM, mikecart1 wrote:

    XOM > AAPL

    24/7/365 Forever

    Don't let iPhones fool you. Everyone on this planet uses oil directly or indirectly.

  • Report this Comment On February 02, 2012, at 7:23 PM, joezizzo wrote:

    This article nailed all the right points on MM/Capital Structure, coupled with the dangers of managers having too much cash on hand to squander. However, the last point offers dividends as the only way to get cash out of the firm. What about share repurchases?

    There's a good reason younger firms avoid the dividend route and go with share repurchases. There are all kinds of signaling and flexibility issues once you commit to a regular dividend. And, dividends are not tax efficient to most investors (ordinary income).

  • Report this Comment On February 03, 2012, at 1:09 PM, Canuck2010 wrote:

    Apple, like a lot of tech companies, uses stock options to compensate their talent. Issuing large dividends would reduce the value of those options and anger everyone from the CEO down to the engineers and programmers dreaming up the next iGadget. That's why you'll never see Apple issue large dividends. You might see some low level dividends start up to appease the "we want our dividends" crowd, but I doubt you'll see a large bleed of Apple's current cash hoard.

  • Report this Comment On February 03, 2012, at 2:13 PM, famulla5 wrote:

    Simple English is best that Steve got.We do not find this calibre of man these days. No I am not being pessimistic but face it, is it not the fact, Words give us plenty men few.



    noun: Someone who is solely interested in cold, hard facts.


    After Thomas Gradgrind, the utilitarian mill-owner in Charles Dickens's novel Hard Times. Gradgrind runs a school with the idea that hard facts and rules are more important than love, emotions, and feelings. Earliest documented use: 1855.


    "In truth, Colleen McCullough is very much a Gradgrind when it comes to facts: They are all that is needful, presented, it must be said, without color or animation to detract from their merit."

    Katherine A. Powers; Ancient Evenings; The Washington Post; Dec 15, 2002.


    Few things are more satisfying than seeing your children have teenagers of their own. -Doug Larson, columnist (b. 1926)/I thank you Firozali A.Mulla DBA

  • Report this Comment On February 03, 2012, at 7:53 PM, becareful1 wrote:

    I normally like dividends but check charts for 1, 3, 5 and 10 years. It looks like Apple is the far better return in spite of Exxon's dividends.

    I do believe that Apple's share price would be significantly higher because of its growth except for the large number of analysts and commentators that keep mentioning "the law of large number" without considering apple's still available markets and market penetration.

    As long as Apple keeps growing, I'll keep owning Apple. After that, I'll consider Exxon since I have a few years until retirement.

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