Ka-ching! Dividend investors live for that sound. Each quarter thousands of companies hand over their excess cash to investors. But not all dividend stocks are equal. In fact, some are straight up risky while others are extremely promising. So how do you find an excellent dividend stock? It's simple. Look for companies with loads of cash. Case in point, Apple (AAPL -1.20%) -- a dividend investor's dream stock.
Two forms of cash
In business, cash comes in two forms: ongoing streams and accumulated hoards. Dividend investors want both.
Of the two forms of cash, the stream is the most important. Dividend investors should be able to rely on the company to throw off plenty of cash on an annual basis for years to come. Apple passes on this front with flying colors. In each of the last five years (and the trailing 12 months), Apple turned more than $0.20 of every dollar of sales into free cash flow, or FCF.
Source: Morningstar.
Apple's FCF-to-sales track record is impressive, handily qualifying the company as an authentic cash cow.
And as far as a cash hoard, Apple delivers. Currently, cash accounts for 36% of its share price. This places Apple squarely at the top among other megacap tech stocks.
Source: Yahoo! Finance.
But having the most cash isn't always a good thing -- at least not if it's just sitting there. In Apple's case, the company has largely addressed this problem in two ways.
- Apple increased its dividend payout by 15% and promised to review its dividend annually.
- The company announced a major boost to its share repurchase program, committing to buy back $60 billion in shares by the end of 2015 compared to its previous commitment of just $10 billion.
Why Apple?
Yes, Apple's dividend yield is substantially lower than other popular dividend stocks like Waste Management, with a whopping 3.5% yield. So what makes Apple better than stocks like Waste Management? Why not Microsoft (MSFT -1.21%), with a FCF-to-sales ratio of 36% (1,000 basis points higher than Apple's) and a nearly identical dividend yield?
Apple's massive cash hoard aside, the pivotal difference is Apple's payout ratio. Payout ratio is defined by a company's dividend as a percentage of its earnings. The higher the ratio, the less sustainable the dividend if things go awry. The lower the ratio, the more sustainable the dividend, and the more room for the company to increase the dividend.
So how does Apple's payout ratio compare to other popular dividend stocks?
Source: Yahoo! Finance.
As you can see, Apple's an all-star on this metric. Waste Management might pay a hefty yield, but there's not much room for future increases. Even worse, the company may be forced to reduce its dividend if earnings come under the weather. Microsoft may generate loads of cash, but its payout ratio is more than twice that of Apple's.
Challengers?
There's no denying it. Apple is an excellent dividend stock -- maybe one of the best. If you can identify a stock out there with a dividend yield in excess of 2.5% that also scores higher than Apple on FCF-to-sales, cash per share, and payout ratio, I'd love to hear about it. Until then, Apple tops the list.
