Alphabet (GOOGL 1.08%) (GOOG 1.06%) has been making headlines this year, and investors are beginning to take notice. The company was reeling last year in the face of the worst economic downturn in a decade, which sent ad spending plummeting. Recent results suggest that the digital advertising market may be on the verge of a rebound. This would be a huge plus for the Google parent, which makes the vast majority of its revenue from online advertising.
Furthermore, Alphabet's ties to artificial intelligence (AI) have also been of keen interest to investors. Recent advancements in the field of generative AI captivated Wall Street and catapulted the stocks of numerous AI companies into the stratosphere. While estimates vary, a conservative forecast courtesy of Morgan Stanley suggests economic benefits of $6 trillion by 2030, and Alphabet is well positioned to participate in that windfall.
Given Alphabet's strong operating history and the vast opportunity AI provides, will the company begin paying a dividend? Let's take a look.
Image source: Getty Images.
A rock-solid balance sheet
Alphabet's recent results help make the case for the company to begin paying a dividend. In the second quarter, the company generated revenue of nearly $75 billion, up 7% year over year. This resulted in net income of more than $18 billion.
Yet that only tells part of the story. Because of its cloud computing and search businesses, Alphabet records billions of dollars in noncash expenses. Depreciation on its data centers and servers is a great example. As a result, the company is actually producing more cash than profits. Alphabet generated nearly $29 billion in operating cash and $22 billion in free cash flow during the quarter.
That brings the total cash and marketable securities on Alphabet's balance sheet to more than $118 billion -- and eventually, the company will have to do something with all that extra cash.
A revenue boost from AI?
AI has gone viral in 2023, and Alphabet is one of the companies best positioned to benefit from recent advancements in generative AI. Businesses are clamoring to benefit from the potential for significant productivity gains made possible by these next-generation algorithms.
As one of the "big three" cloud infrastructure providers, Alphabet is scrambling to make generative AI available via its Google Cloud, which will undoubtedly boost the company's fortunes. Daniel Loeb of Third Point agrees, calling Google Cloud one of the "picks and shovels of the AI gold rush," which will benefit no matter who else comes out ahead.
Furthermore, the company has added a host of new AI tools to its portfolio of products, including Bard chatbot, which launched internationally last month.
While it's nearly impossible to calculate, Alphabet has plenty to gain from its foray into AI -- and even more resources to initiate a dividend.
Why pay a dividend?
So why do companies pay a dividend? In the most general terms, it's a way to return capital to shareholders. A company will typically take this step when the amount of cash it takes in is more than it can use to generate additional growth.
Take Apple for example. In its fiscal third quarter (ended July 1), the company generated revenue of $83 billion. Even after spending nearly $7 billion on research and development and paying all its other expenses, Apple still had net income of $19 billion and operating cash flow of $26 billion.
There's a misconception among investors that once a company starts paying a dividend, its growth is over, but as Apple has shown over the past decade or so, that's patently untrue. The iPhone maker resumed paying a dividend in 2012 and, since that time, expanded its payouts by 154%. During the same period, its stock increased by 729% -- which should put to rest any fears about stalling growth.
Data by YCharts
Because of the company's significant cash generation, Apple uses just 16% of its profits -- called a payout ratio -- to fund its dividend. Let's use that as a starting point to estimate what Alphabet could pay.
Even amid the worst downturn in decades, Alphabet still generated net income of roughly $60 billion last year. If the company were to use 16% of that amount to fund a dividend, that works out to just under $10 billion or roughly $0.76 annually per share, with a yield of about 0.5% -- slightly higher than Apple's current yield of 0.4%. If Alphabet opted instead to pay out 25% of its profits, that would work out to about $15 billion, resulting in a payout of $1.19 per share annually, or a yield of about 1%.
Given what we know, Alphabet could undoubtedly afford to pay a dividend -- if it decided to do so.
Will Alphabet pay a dividend?
It seems the company has plenty of resources, so why doesn't Alphabet pay a dividend? In its 2022 annual report, management addressed the issue, writing: "We have never declared or paid any cash dividend on our common or capital stock. The primary use of capital continues to be to invest for the long-term growth of the business." That said, the company didn't rule out paying a dividend in the future: "We regularly evaluate our cash and capital structure, including the size, pace, and form of capital return to stockholders."
That's generally corporate double-talk for "not yet." However, given Alphabet's mounting cash pile, strong cash generation, and the additional opportunities afforded by AI, I would suggest that the question isn't if Alphabet will pay a dividend but when. In my opinion, it's only a matter of time.
