Should Apple start paying a dividend? – A discussion in the context of financial theory

Apple is one of the most successful and popular companies in the world. It is also a company that is going through a state of change as a result of the death of its charismatic former CEO and co-founder, Steve Jobs.

As well as this, it is a company that declined to pay dividends to its stockholders since 1995.

Using my knowledge acquired through the study of applied finance, I will explore the topic of dividends, paying special attention to Apple and offer my thoughts regarding the position of dividends in Apple’s future.

To begin with I will offer a short explanation of my understanding of the significance of dividends, or the lack of them as the case may be and then apply this to Apple’s situation.

Dividends are defined as ‘A distribution of a company’s earnings, decided by the board of directors, to a class of its shareholders,’ (Investopedia).

What a company tends to do with their end of year earnings varies greatly depending on many different factors.

The growth prospects of the company and a history of dividend issues are two of the most important factors.

Dividends hold a special position in finance as they signify the relationship between the stockholders and the management.

How much dividends a company tends to pay can tell you a lot about that company. In general, companies in high-growth markets tend not to issue dividends. This is because companies in high-growth markets generally tend to have good projects that earn the minimum acceptable risk related hurdle rate. Management take it upon themselves to reinvest any earnings made by the company into projects they believe will yield a greater long-term return for stockholders. This is most certainly the case with Apple, who have had a string of exceptionally successful projects in its history under Jobs.

If a company believes that any investments made will yield less than this rate then they should return the cash to the investors in the form of a dividend.

Once a company begins to pay dividends it is very difficult to stop or cut them. This is due to the signaling content of dividends. Because dividends hold a significant position of importance as the relationship between the company and it’s stockholders, any cut or stoppage of dividends can signal problems for the company. This may lead to falling stock prices or worse, although there is some evidence to suggest that the signal strength of dividend changes has declined in recent decades.

The power of dividend signaling is an issue that has lead to companies being hesitant to begin issuing dividends.

This is likely not an issue that would effect any issue of dividends by Apple in the short to medium term as Apple are an extremely cash rich company. They would have no problem financially issuing a modest dividend.

There are many different profiles to stockholders. Some are happy to forego any short term cash inflows from dividends if they believe it will benefit them in the future, others such as retired individuals looking for a cash inflow to supplement their pensions may be primarily interested in companies seen to deliver a consistent dividend. There are no shortage of investors eager to own a piece of Apple, so this lack of dividend payouts is unlikely to deter any significant number of investors from buying shares in the company.

When Jobs re-joined Apple in 1997 they were near bankruptcy. At the time of his death Apple was one of the most popular companies in the world with something in the region of 81 billion dollars in cash and marketable securities in the bank, more than the US government. Jobs always seemed particularly averse to issuing dividends claiming that this large cash saving “gives [Apple] tremendous security and flexibility.” This stands true to this day. Apple are currently in negotiations to buy Israeli company Anobit to supplement their flash storage technology, which may lead to significant increases in the battery life of their products. These ventures justify to a degree Jobs position on the matter.

The question for Apple’s new CEO Tim Cook is whether they really need a safety net larger than the cash available to the world’s largest economy or there are better uses for a portion of this cash, either within reinvestment in the company or a dividend issue.

Image

(Cook and Jobs)

 

The issue of dividends is sometimes viewed as a declaration by a company that they have passed the rapid growth stage and have matured as a company. Should Apple issue a dividend in the near future, soon after Jobs’ death it may be viewed as a statement that the loss of Jobs has brought about an era of slower growth and innovation for Apple, which may in fact harm the company. Others would view it as a logical step for a company with such massive cash holdings.

Apple would like to maintain their position in the upper-right corner of the below dividends matrix. This affords them the greatest flexibility in setting dividend policy going forward.

Image

 

Other large-cap tech companies such as Microsoft, Cisco and IBM have all chosen to offer their stockholders regular dividends while continuing to reinvest in projects within their companies.

There are tax issues at play with regards to Apple issuing dividends for Cook to consider as well. As dividends are usually taxed at higher rates than capital gains it may be considered wasteful for Apple to issue dividends considering its recent history of extremely successful enterprises.

A recent 10-k form filed by Apple also shows us that significant portions of Apple’s cash holdings are held abroad. Upwards of 50% of their holdings may be subject to taxes as a result of repatriation. Estimates have put this cost to Apple at around $5 billion should they choose to repatriate this cash for a dividend payout.

All things considered I believe that an Apple dividend payout is inevitable. I also believe a premature dividend payout may be harmful to the company in the short term, and the company will benefit from staying strong and proving that it has the drive to reinvest earnings into successful projects without Jobs to steer the ship. Tim Cook will eventually break from the past and issue a modest dividend payout, that much is inevitable, but not necessarily imminent.

 

References:

 

Do dividends matter more in declining markets?” Fuller, K.P., & Goldstein, M.A. Journal of Corporate Finance, 17 (3), (2011).

 

“Evidence on Irish financial analysts’ and fund managers’ views about dividends.” McCluskey, T., Broderick, A., Boyle, A., Burton, B., & Power, D. Qualitative Research in Financial Markets, 2 (2), (2010).

 

“Evidence on the Irish stock market’s reaction to dividend announcements.” McCluskey, T., Burton, B., Power, D. & Sinclair, C. Applied Financial Economics 16 (8), (2006).

 

“Earnings information conveyed by dividend initiations and omissions.” Healy, P. & Palepu, K.G. Journal of Financial Economics, 21 (2), (1988).

 

Apple Earnings Releases – Apple.com

 

Financial History (Dividend History) – Apple.com

 

“Apple Now Has More Cash Than The U.S. Government.” Rosoff, M. Business Insider, 28/07/11.

 

“Apple: Dividend time?” Savitz, E. Forbes.com, 03/11/11.

 

“Apple in talks to buy flash storage maker Anobit.” Kennedy, J. SiliconRepublic.com, 13/12/11.

 

“Apple dividend a likely possibility” Razi, N. SeekingAlpha.com, 09/12/11.

 

“Why doesn’t Apple pay a dividend?” Ghosh, P.R. International Business Times, 07/01/11.

 

Prof. Brian Lucey, TCD. JS Applied Finance lecture slides.

 

Investopedia.com

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