Many dividend investors have turned to Apple (NASDAQ: AAPL ) in the past two years for income. After initiating a dividend in 2012, its meaningful yield combined with robust free cash flow made a recipe for a great long-term dividend stock. Even better, a good portion of the past two years Apple stock could have been purchased below $500; at those levels the stock was clearly an excellent dividend stock. But is Apple still a good dividend stock after its recent run-up?
For the most part, three criteria make or break a stock as a good pick for long-term income: staying power, profitability, and yield. Let's see how Apple measures up on each of these items.
An ecosystem built to last
A sustainable competitive advantage is arguably the most important factor an investor should look for in any investment -- dividend stock or not. These competitive advantages can come in several forms; some of the most common are cost advantages, intangible assets (like brands and patents), network effects, and switching costs.
What is Apple's competitive advantage? While the company certainly benefits from several different types of advantages, its best (and most undervalued) advantage is its ecosystem that seems to lock customers in once they buy an Apple product. You won't find this asset on the balance sheet, but don't be fooled -- it's there.
Apple's management team and other analysts and investors refer to Apple's effective ecosystem as a halo effect. It derives its power mainly from Apple's seamless integration of software, hardware, and services. For instance, an iPhone buyer gets access to the App Store, iTunes, and easy integration to other iOS and OS X devices.
This halo effect makes Apple's ecosystem "sticky," helping Apple achieve unorthodox customer retention rates across all of its hardware sales. Most importantly, this halo effect gives Apple the staying power needed to qualify the business as an excellent long-term investment.
A cash cow
So, Apple has staying power. But does it boast the profitability needed to be able to pay out a meaningful dividend? Absolutely. Apple's gross and net profit margins are 37.5% and 21.3%, respectively -- not bad at all. But the best perspective of exactly how much cash Apple is producing can be seen by looking at the company's free cash flow relative to sales; the company is ultimately converting about $0.25 of every dollar of sales into free cash flow. What is free cash flow? It's the good stuff management can use to build shareholder value -- the cash left over after operating expenses are taken care of. And most importantly for income investors, it's the cash that can be used to pay out dividends.
An OK yield poised for meaningful growth
After the recent run-up in Apple's stock price, its current dividend yield of 2.2% isn't very enticing. But where Apple lacks in yield today it makes up for in growth tomorrow.
Not only did the company announce in April that it plans to increase its dividend annually, but Apple's very low payout ratio also suggests there is plenty of room or further increases. A payout ratio is simply equal to the company's current dividend payout divided by earnings. The lower the ratio, the more sustainable the dividend if things turn sour, and the higher the probability of dividend increases in the future. Today, Apple is paying out only 29% of its earnings in dividends.
So, is Apple still a good dividend stock at $600? Yes. Sure, the yield isn't fantastic today. But income investors shouldn't rely completely on yield as a deciding factor for a dividend stock. Investors should also demand that the business is excellent and reasonably priced. Apple's sustainable and superior economics and likelihood of further increases in the dividend help qualify Apple stock as a good investment for income investors, even with a fairly small yield today.
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