Editor's note: an earlier version of this article incorrectly stated that Apple has $194 million in cash, cash equivalents, and investments. It has been updated to the correct unit -- billion.
Apple (NASDAQ:AAPL) stock attracts a lot of attention from both investors and the media. However, most eyes are usually focused on factors such as iPhone 6 sales, or the market potential for the recently released Apple Watch, while dividend announcements don't typically receive the attention they deserve. This is understandable to some degree; Apple has a relatively short history of dividend growth, and the dividend yield is not particularly high in comparison to other names in the tech industry.
On the other hand, Apple has what it takes to become one of the most remarkable dividend growth stories in the market over the years ahead, and this could mean big returns for investors in Apple stock over the long term.
Looking for dividends in the tech sector
Apple reinstated its dividend in 2012 and increased payments by 15% in 2013, 8% in 2014, and 11% in 2015. The quarterly payment is now at $0.52 per share; this means a dividend yield of 1.7% at current prices, which is not particularly exciting in comparison to other big tech companies.
IBM (NYSE:IBM) has an amazing track record of dividend growth. The company has paid uninterrupted dividends since 1916, and it has increased payments for 20 years in a row. Big Blue has doubled its dividends in the last five years, including a recently announced dividend increase of 18% for 2015. After the latest increase, IBM stock yields nearly 3% in dividends.
Microsoft (NASDAQ:MSFT) is another tech giant beating Apple when it comes to both dividend yield and dividend growth trajectory. Microsoft has raised its dividends every year since 2003, and the company is currently paying $0.31 per share, which means a dividend yield in the neighborhood of 2.7%. Microsoft typically announces its dividend increases in September, so the company has not yet raised dividends for 2015.
IBM and Microsoft, big tech companies with successful trajectories of dividend growth and higher yields than Apple, are just two relevant examples to consider. The main point is that, when looking at current dividend yields and recent dividend history, Apple does not look like the most attractive dividend stock in the tech sector.
On the other hand, investment decisions need to be based on forward-looking considerations and future potential. Past performance and current conditions can provide important information, but investors need to look forward, though the windshield, not the rearview mirror, when analyzing dividend stocks. With this in mind, it's important to note that Apple's dividend growth potential comes second to none.
Apple has nearly $194 billion in cash, cash equivalents, and investments on its balance sheet. Even after deducting $40 billion in long-term debt and $3.8 billion in commercial paper obligations, this still leaves Apple with an enormous net cash position of over $150 billion.
Even better, the business generates massive amounts of money every quarter. Operating cash flow during the six-month period ended March 28 was $52.8 billion, a 46% increase from $36.2 billion in the same period during 2014. Free cash flow in the first two quarters of fiscal 2015 was $47.2 billion, a 44% year-over-year increase.
Apple allocated only $12 billion to share buybacks and $5.5 billion to dividends over the last six months. This means cash flow generation provides enormous room to increase dividends and buybacks in the future.
Management is prioritizing share buybacks over dividends when it comes to overall capital distributions. This is the smart thing to do if you think Apple stock is undervalued at current prices, and management clearly believes that is in fact the case. In the words of Luca Maestri, SVP and CFO: "We're allocating the majority of the expansion of the program to share repurchases, given our strong confidence in the future of Apple and the value we see in our stock."
Big buybacks are taking financial resources away from dividends now, but they can be a major plus when it comes to dividend growth potential. As the amount of shares outstanding shrinks over time, Apple can pay higher dividends per share for every dollar of cash flow, so big buybacks in the present can mean big dividend growth in the future.
Growing dividends don't only provide income to investors, they are also a powerful and transparent signal about a company's quality and financial strength, and this is a major return driver over time. Apple is on track to deliver substantial dividend growth over the coming years, and this is a big plus for investors in Apple stock.