With those near retirement unlikely to find a certificate of deposit yielding anything close to 2%, dividend stocks have taken center stage. And why shouldn't they? These companies are usually proven winners that spew tons of cash.
Usually, investors like yields over 2% that don't eat up too much of a company's free cash flow. In that respect, Apple (NASDAQ: AAPL) fits the bill.
But I don't think chasing yield is the most instructive approach. While the health of a dividend is important, as a long-term investor, I'm much more interested in what kind of yield I'll be getting five and 10 years from now based on a purchase today.
That's where the real compounding magic of dividend investing happens.
A deeper explanation
We'll get back to Apple in a second. First, I want to focus on one of tech's longest-tenured dividend payers: IBM (NYSE:IBM).
If you bought IBM 10 years ago, you would have been entitled to its $1.20 annual dividend. At $75.50 per share, it was a 1.6% dividend yield -- not bad but not terribly impressive, either.
But here's the twist: If you continued to hold those shares -- in other words, if you did nothing -- you would now be getting $5.60 deposited in your account for every one of those very same shares. That amounts to a whopping 7.4% dividend yield on your original purchase.
Dividend investors would die for a yield like that.
If you are more than a decade away from retirement, finding stocks like this is the key to producing steady streams of relatively safe cash flow. Investments like IBM share a few key attributes that we'll look for in Apple:
- A history of dividend growth
- Relatively low (below 70%) amounts of free cash flow being used to pay the dividend
- A solid moat surrounding the business
How does Apple's dividend stack up?
On March 19, 2012, CEO Tim Cook announced that Apple would once again start paying a dividend. Adjusting for splits, it amounted to $1.52 per share, or a yield of roughly 1.8%. In the four years since then, that dividend has grown at an annual rate of about 11%; shareholders now get an annual payment of $2.28 per share.
If we look at the health of Apple's dividend, it becomes clear that the company has more than enough free cash flow to continue raising its dividend for the foreseeable future.
In no year has the company used more than one-quarter of its free cash flow to pay its dividend. Let's put in perspective how low -- and healthy -- that is. In 2014, Intel, another tech player with a long history of paying dividends, used 43% of its free cash flow to pay its dividend -- still low but almost twice as much as Apple's.
The takeaway is clear: If things continue on the same trajectory, it wouldn't be far-fetched to assume that Apple can continue to grow its dividend by 11% per year safely. That would give it an annual payment of $6.47 per share in 10 years -- a whopping 5.9% dividend yield from today's prices.
But about that moat...
The key question, however, is whether Apple will be able to continue generating such copious free cash flow a decade from now. The company has two competitive advantages that are somewhat sustainable: It has the most valuable brand in the world, and it has developed an ecosystem that has mildly high switching costs.
What I mean by the latter is that if you have your songs, pictures, and calendar on the iCloud -- and all of your devices are connected, you might be loathe to start using a different smartphone. At the same time, however, Alphabet's Android operating system can do the exact same thing, and you're likely already using many of Google's devices.
In reality, the key engine that keeps pushing Apple forward is the fact that it has consistently come out with the "Next Big Thing" in technology. In started in 2001 with the iPod, exploded with the iPhone in 2007, and got a nice bump with the iPad in 2010. The Apple Watch hasn't been much of a needle-mover, especially since you need to own an iPhone to enjoy full functionality.
Other dividend-paying stalwarts -- especially in consumer goods products like cigarettes, toilet paper, and jelly -- rely solely on their brand for a moat. That might sound weak, but these products have barely changed in the past 50 years. That's simply not the case in technology, which should give long-term dividend investors some pause.
A final verdict on Apple's dividend potential
Without a doubt, Apple's dividend is one of the strongest in all of technology. The problem is that it's in the industry of technology, where things can change in the blink of an eye. If you're looking for a dividend that could offer a bigger yield with lower risk 10 years from now, I think there are better options out there.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Brian Stoffel owns shares of Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Intel. 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.