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1 More Reason Apple Inc. Shouldn't Raise Its Dividend Significantly

By Ashraf Eassa - Feb 10, 2016 at 3:25PM

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Buybacks are easier to modulate and, more importantly, create lasting value for long-term shareholders.

Bill Maurer, writing for Seeking Alpha, argues that it would be better for Apple (AAPL 1.70%) to focus on significant share repurchases than on instituting a large increase in the dividend. His logic is sound, saying that -- since much of Apple's cash is held overseas -- it makes more sense to borrow money to buy back stock (which improves earnings per share) rather than to simply distribute it to shareholders.

I'd like to offer up another, perhaps less conventional reason why Apple should focus the bulk of its capital return program on share repurchases rather than a large step up in the dividend.

Apple needs to leave a runway for future increases
Right now, it's not at all clear if Apple will be able to return to net income/free cash flow growth in the near future. However, at the current dividend level of $11.52 billion per year, it can afford to pay this out even if business slows considerably from here. Indeed, it could even raise the dividend for quite a while even if the company faces a couple of years of net income declines.

However, if Apple raised the dividend substantially, perhaps to $4 per share as some have suggested, then it would be on the hook for more than $22 billion per year.

Now, it could afford to pay this for quite a while (although it would probably need to borrow to do so given how much of its cash is held/generated overseas), but it would be pretty tough for the company to be able to commit to annual dividend increases at that point for as long as the business is in no-growth/contraction mode.

Dividends don't create lasting long-term value
Dividends are great for income investors, and I'm sure Apple wants to attract the typical dividend growth crowd to its stock, hence the dividend and the commitment to increase it on an annual basis.

However, while dividends line the pockets of today's shareholders, they really do very little for the company's stock over the long term. Share repurchases reduce the company's share count, which for a given level of net income, leads to improved earnings per share.

Consistent, large share repurchase activity can create lasting value in ways that large dividends simply cannot.

Buybacks can be pared back, but dividends are much harder to
This isn't to suggest that Apple is at much risk of having to cut its dividend anytime soon, but let's suppose that Apple, for whatever reason, simply needs to scale back its capital return activity. Paring back, or even suspending, a share repurchase program isn't the sort of thing that sends (most) investors immediately running for the hills.

However, when a significant portion of the shareholder base owns the stock with expectations of consistent quarterly dividend checks and those checks suddenly get a lot smaller or even disappear, many of those shareholders simply throw in the towel. That often means a substantial decline in the share price.

What to expect in April
Apple generally updates its capital return program in April and is expected to do so then this year. According to CFO Luca Maestri on the most recent earnings call, the company has completed over $153 billion of the current $200 billion capital return program that's currently in place.

I'm not expecting a significant increase in this authorization in April, but a bump of about $30 to $50 billion to the existing program should do the trick. Expect this in the form of an increased dividend (but not hugely so) and, of course, share repurchases.

Ashraf Eassa has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. 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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