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Why Apple, Inc. Is a Better Dividend Stock Than You Think

By Daniel Sparks – Aug 20, 2015 at 8:00AM

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Apple is still one of this analyst's favorite dividend stocks.

For investors looking for income, there are a number of excellent dividend stocks with yields greater than 3%. Indeed, there are probably a handful of dividend stocks worth owning for the long haul with yields above 5%. Better yet, a fraction of these stocks likely increase their dividend every single year.

With this said, some investors may wonder how could Apple (AAPL -3.00%), with its paltry dividend yield of 1.8%, could be considered an excellent dividend stock?

Apple's dividend
Under Steve Jobs' leadership, Apple never paid a dividend. Yes, between Jobs first and second reign at Apple, the company did pay a dividend, but it wasn't until Tim Cook took over the tech giant and its cash hoard was approaching $100 billion that its board told investors it was again actively discussing a dividend. And then in 2012, after its cash had swelled to $117 billion, it finally paid out some cash to shareholders.

Meanwhile, Apple's cash reserve has only grown. It now holds $202.8 billion in cash and marketable securities. 

Since it reinitiated a dividend in 2012, Apple has increased its dividend three times -- once every year. And management has said it plans to continue this practice going forward.

Why Apple is a great dividend stock
Today, Apple has the key qualities of an excellent dividend stock. Indeed, a close look at the drivers for the tech giant's dividend reveal substantial room for upside in the payout.

Here are three reasons dividend investors should be excited to hold Apple in their portfolio despite the stock's short dividend history and its fairly low dividend yield today.

1. Apple is an excellent company. Every buy-and-hold investor, whether they are looking for income or not, should first ensure their investment has the characteristics of an excellent company.

Even without analyzing Apple's financial statements, it's probably pretty clear to most investors that Apple isn't going anywhere. The company has legions of highly loyal customers deeply ingrained in the Apple ecosystem of pricey gadgets. And this ecosystem has continually grown beyond products, as Apple builds out its software and services with iTunes, Apple Pay, Apple Music, and more.

But for those wanting more proof of the company's staying power, a quick glance at its financial statement reveals unorthodox gross profit margins that have ranged between 29% and 44% during the past 10 years -- clear evidence of Apple's consistent pricing power with customers and its scale.

2. Exemplary capital allocation. Even before Apple began paying a dividend in 2012, it could be argued that the tech giant was a grade A example of excellent stewardship. When Jobs returned to the company for the second time as CEO, every dollar spent on R&D, marketing, and acquisitions seemed to churn out a handsome return on investment. And relative to the company's size, Apple has always avoided overspending on acquisitions (an unhealthy habit that has plagued Microsoft for years).

This excellent fiduciary responsibility continues today; management has proven to be opportunistic with buybacks -- and it has worked wonderfully. Aggressively repurchasing shares, its share count is down 13% since the program began in 2012. Better yet, Apple has repurchased the majority of these shares at prices well below where the stock is trading today.

3. Boatloads of free cash flow. A look at the company's financial statements shows there's plenty of room for future dividend hikes.

Apple's free cash flow in the trailing 12 months is a whopping $69.4 billion. Calculated by subtracting capital expenditures from cash flow from operations, this is the cash generated from its business after all necessary expenses to maintain Apple's current business and after cash used to invest in growth. In other words, free cash flow is the good stuff left over to be used in activities like dividends, share repurchases, and future acquisitions.

And Apple is currently only paying out a fraction of this free cash flow in dividends. In the trailing 12 months, Apple paid out $11.4 billion in dividends.

Source: Apple.

Another way to analyze the potential upside for the company's dividend is to calculate the payout ratio, or the percentage of earnings paid out in dividends. Apple's payout ratio is just 22%.

To be fair, much of Apple's cash is overseas, making it difficult for the company to pay it out to shareholders. And Apple's preference for returning cash to shareholders may continue to skew toward repurchases. But even after continued repurchases and the limitations of overseas cash, the tech giant's significant free cash flow and comparatively small payout in dividends leave room for meaningful dividend increases for years to come.

Sure, the opportunity for dividend investors in Apple stock may not be as enticing as it was in 2013 when shares were trading at about half where they are today, but the opportunity for income and share appreciation is still looking good.

Daniel Sparks owns shares of Apple. The Motley Fool recommends and owns shares of Apple. It also owns shares of Microsoft. 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.

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