Portfolio Manager Alex Ruehle of Denver Investments says Apple Inc. (NASDAQ:AAPL) has both an attractive valuation and strong capital allocation behavior, and he expects the company to increase its dividend payments at a 10% annualized pace over the next five years.
There are two big-picture points I’d like to make. First of all, the stock has a very attractive valuation. When we began looking at it as it pulled back into the $90 range we concluded that the stock was simply too cheap given the power of its brand coupled with the upcoming iPhone 7 product cycle. At that point the stock was embedding very bearish expectations: 10% annual revenue declines through 2025, while margins were priced to deteriorate from 28% down to 18% — all while we were discounting the cash flows at a conservative 10% cost of capital. This seemed wholly unreasonable and gave us a large margin of safety going into a product launch for which many had low expectations.
Secondly, the company’s management team exhibits attractive capital allocation behavior. Apple has been reducing shares at a nice pace. Over the past three years they’ve actually reduced share count by 17%. Moreover, the company started their dividend policy in 2012 with a 6% payout. At the end of 2015, Apple was paying out just 21% of earnings in dividends.
Considering the low payout, we felt the dividend policy was ripe for a change. Indeed, we have seen 11% compounded annual growth in the dividend over the past four years. Apple currently pays a 2% dividend yield, and we anticipate that they will increase their payment at a 10% annualized pace over the next five years.
We believe that investors overlook Apple as a dividend growth vehicle. To put their dividend into perspective, the company has over $260 billion in cash. That’s $47.50 per share or nearly 25 years of dividend payments just sitting in cash. Given management’s past behavior, we think that future capital allocation decisions will continue to create value for shareholders.