I once saw an elephant show in northern Thailand. The animals paraded out from a holding area with their trainers, decorated and eager to entertain. They performed dog-like tricks, sitting, lying down and even fetching. The highlight for me was a pickup game of soccer where the elephants kicked the soccer balls into an over-sized goal. My travel companion was an animal lover and we weren’t quite sure what we were signing up for before the show started. She was horrified by the way the trainers treated the animals and we ended up leaving after 20 minutes.
The trainers controlled the elephants by whacking them with a five inch hook on the end of a stick, guiding the animal in the direction they wanted it to move. Even I was a bit horrified by this treatment, but the elephant didn’t seem to care. They have very thick skin. They just went where the trainer led them, performed their tricks, and in the end went back to the holding area to do what elephants do best. Eat and grow huge. If at any time they were angry at their trainers, they could have easily trampled them (assuming they were not hit by a tranquilizer). But they never did because the trainers fed them, and all they care about is food.
Elephant Chain – We’re in this Together
Take a look at my portfolio and you’ll notice a pattern. I’m a dividend growth investor, and almost all of the companies in my portfolio have been paying and often increasing dividends for more than 25 years. Even after the financial crisis, Bank of America (BAC) still continues to pay a $.01 quarterly dividend and hopefully will increase it this year. But one large stock in my portfolio stands out for only paying a dividend for just two years. This tech stock historically never saw the need to pay a dividend, instead opting to remain flush with cash and investing in new products to spur growth. That pachyderm is Apple (AAPL).
Not only do I hold Apple in my taxable account, I have plenty of exposure through a number of mutual funds and index funds in my retirement accounts. If you own US stock mutual funds or market index funds, you certainly own Apple too. Owning a piece of Apple is nearly unavoidable in today’s world. At a market cap of 450 billion, it’s one of the largest companies in the world and money managers inevitably park their money in this mammoth. I previously owned this stock a few years back and sold it, but that’s another story.
Elephantitis of the Balance Sheet
My household owns two iPhone 5’s and one iPad 2. I previously used a 3G, and my wife put a 4S through the spin cycle with a load of poopy cloth diapers. We are considering getting an Apple TV and an iMac. We use iTunes to buy, manage, and now listen to music (with iTunes Radio), and we’ve bought a few apps on our devices. We download shows for our kids to watch on the iPad for long road trips. Overall I am a believer that Apple makes great products that improve the quality of my life.
But this has little to do with why I own the stock.
I own the stock for another reason. The stock pays me cash. And at this point in time, the cash coming my way is very secure and likely to grow in the near term.
Sure, there is always the chance for appreciation in the stock price too, and if it gets to be overvalued in the future, I may sell it. In fact, I probably won’t hold Apple until my retirement date in 2031. But today there is a solid floor because Apple buys back stock on a regular basis, and value and income institutional investors are picking up more shares while the growth investors bail.
In the meantime, at $500 Apple yields about 2.44%. My yield on cost (YOC) is closer to 2.6%. The payout ratio is 29%. While they are aggressively buying back the stock, they still managed to save another 12 billion in cash this past quarter raising its total cash hoardings to $159 billion. Sure, some of this is stuck overseas, but they’ll figure out a way to maximize the use of those funds and minimize taxes when the time is right. The number $159 billion is outrageous by any measure. Apple has elephantitis of the balance sheet.
On April 23rd of 2013, Apple announced a 15% increase in their dividend. Is there enough cash flow to increase it again this year? Undoubtedly, yes. And there’s always the potential for a special dividend too, and more stock buybacks. Another 15% added to today’s dividend would increase the dividend to about $14 per share and would push the yield to 2.80% and my YOC to 3%. We should be hearing about an increase sometime in April.
The Earnings Circus
On Monday, Apple announced what Wall Street analysts considered to be disappointing earnings. They only sold 51 million iPhones at an average price of $636 instead of the expected 56 million. iPad sales were up 14% and iMac sales increased 17% year over year. Quarterly net income was flat compared to the prior year at $13 billion. But earnings per share (EPS) was up $.69 at $14.50/share due to share buybacks.
This was a massive disappointment. Management is pathetic. Apple has created no new product categories since Steve Jobs left. Tim Cook can’t innovate! These are all criticisms I’ve read over the past few days.
Prior to earnings, all the analysts on CNBC were looking at the iPhone sales number to gauge quality of earnings. iPhone sales missed expectations and the stock tanked 8%. How on earth can Wall Street analysts predict how many phones a company is going to sell in a 3-month period anyways? It’s a ridiculous quarterly practice that frankly shows the absurdity of Wall Street analytics.
OK, so maybe today Apple isn’t as reliable a growth stock as it’s been in the past. But it sure is a cash cow.
All this negative talk is… irrelephant. Apple continues to do what it does best. It makes great products and creates massive amounts of cash; cash they pay to me, and will pay me more of it in the future in the form of dividends, buybacks and/or acquisitions. When all this criticism hits their thick skin like a five inch hook, management just ignores it. They even have a little trainer (Carl Icahn) trying to hook and steer them in another direction to buyback even more shares. Maybe they go in that direction, maybe not. Regardless, they’ll keep doing what they do best. Creating great products and making huge amounts of money. If they ever show any real signs that their ability to generate cash is waning in the future, I’ll sell.
The Feeding Trough
Tim Cook probably hangs out in his Cupertino office knowing what’s in the product pipeline and laughs at the Wall Street analysts. With a new product, Apple is uniquely positioned to disrupt entire industries like they did with music, mobile phones and personal computing. Ripe for the taking today is home entertainment, payments, and wearable devices, all of which fit seamlessly into the so-called Apple ecosystem.
The biggest complaint I read about is Apple’s lack of new products. Does anyone out there actually think there are no new products on the way? An iWatch – an integrated TV – a product to eliminate the need for credit cards – a better version of Google glass – some product no stock analyst has thought of yet? Of course they are innovating, and Apple has many of the best brains in Silicon Valley working on it. And remember, Apple isn’t always the first to market. They wait until the market is ready for an improved product, then make the best product and dominate. The other companies scramble to catch up while Apple is already perfecting the next big thing. Nifty watches, mobile payment methods and fancy TVs already exist, but can those products be made better under the Apple ecosystem? You bet.
When Microsoft (MSFT) was building the Zune to catch up to Apple’s iPod, Apple was perfecting the iPhone. Now that everyone is trying to make a smart phone as good as the iPhone, Apple is working on perfecting something else. When that product comes out, the fidgety growth stock investors will come roaring back and the share price will increase again. That is likely when I’ll sell.
Think about it… if Apple announces tomorrow that they have an event in two weeks to introduce a new product, how would the analysts react? And there’s room for enormous acquisitions and endless research and development, so there is no telling what’s up their sleeve. With $159 billion in cash, they can put whatever they want up their sleeve.
Apple doesn’t really fit the mold of the rest of the stocks I own. But I am patient, and Apple in my view is very low-risk value and income stock. My basis is at a decent price, they pay me dividends to hold the stock, and the future holds great potential for a company with a history of magnificent execution and all the cash they need. For now, this elephant is welcome to stay for a while.
Disclosure: Long BAC, AAPL