Friday, August 25, 2017

Apple: A Growth or Dividend Growth Stock?

When I first purchased shares of Apple (AAPL), it was way after their original stock surge. I added AAPL to my portfolio once they raised their dividend for the first time, right before the stock split. At that time, there were lots of concerns around the company’s ability to “survive” in the smartphone industry and continue to generate growth. After a thorough analysis, I made the bet that AAPL would become another Microsoft (MSFT); a company generating strong cash flow and increasing its dividend generously. Almost 5 years after my first trade, let’s look at Apple and its dividend growth potential.

What Makes Apple a Good Business?

Apple is an icon of the techno which survived the techno bust in 1999. Their products are made with great attention and aim at perfection. While its products are not perfect (yet), it has built a perfect product ecosystem. Your MacBook, iPad, iPhone, and your Apple Watch all blend together. You can share your pictures, favorite songs, and applications with any device. Apple has succeeded to have fans instead of customers.

Revenue

Revenue Graph from Ycharts
The company is still highly dependent of how their iPhones sales are going. For example, during their latest quarter (Q3 2017), the company shows 55% of its sales coming from the iconic smartphone:
Author’s chart, AAPL Q3 2017 numbers
While this seems like a red flag to many investors, I see something else: a year ago, iPhones were 65% of its revenue (source MarketWatch). Considering the iPhone 7 was launched in September 2016 (after the MarketWatch article has been written), we see the company is reaching serious momentum in their Services division. Over the past 12 months, this sector has increased its revenue by 22%.

How AAPL fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.
Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income-seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple: when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly comes with dividend growth and this is what I am seeking most.
Source: data from Ycharts.
As far as my first principle goes, we can’t tell AAPL has a high dividend yield! This is probably what an income seeking investor will tell you if you asked about their opinion on this stock. Unfortunately, a 1.50%-2% yield doesn’t attract the dividend-growth crowd. After all, don’t forget that MSFT started just like that:
Source: Ycharts.
AAPL meets my 1st investing principles.

Principle#2: Focus on Dividend Growth

Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?
Source: Ycharts
What really matters to me is the dividend growth. While AAPL dividend growth history is relatively new, it shows the kind of trend I’m looking for. With a 10.58% CAGR dividend growth rate over the past 5 years, AAPL is up to a great start to become a Dividend Achiever in no time.
AAPL meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.
Source: data from Ycharts.
While management’s committed to provide shareholders with ever-growing dividends, the company has lots of room to meet its promise. You can expect a double-digit dividend growth for the next decade.
AAPL meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

I don’t think Apple is a one trick pony at all. It used to rely on its MacBook sales for a while, then it invented the iPod and surfed on this wave for a while. The current “new trick pony” is the iPhone, but Apple is already working on various other products. In the meantime management can enjoy what is the most important thing for any company… cash flow!
Source: Ycharts
Apple is an innovative company that has the resources and the will to continue in this path.
AAPL still shows a strong business model and meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect timing to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:
Source: data from Ycharts.
After being given a very low multiple for about 2 years, AAPL seems to be back to its average valuation. Mind you, I think there is still room for a higher multiple considering the current market valuation.
Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend-growth investor, I’d rather see companies like big money-making machines and assess their value as such.
Here are the details of my calculations:
Input Descriptions for 15-Cell MatrixINPUTS
Enter Recent Annual Dividend Payment:$2.52
Enter Expected Dividend Growth Rate Years 1-10:10.00%
Enter Expected Terminal Dividend Growth Rate:8.00%
Enter Discount Rate:10.00%
Discount Rate (Horizontal)
Margin of Safety9.00%10.00%11.00%
20% Premium$389.63$193.54$128.23
10% Premium$357.16$177.41$117.54
Intrinsic Value$324.69$161.28$106.86
10% Discount$292.22$145.15$96.17
20% Discount$259.75$129.02$85.48
Please read the Dividend Discount Model limitations to fully understand my calculations.
According to the DDM, AAPL currently trades at its fair market value. However, if I had to initiate a position in AAPL, I would gladly do it at fair market value. This is the type of company that will show a great combination of dividend growth and capital growth in the future.
AAPL meet my 5th investing principle but with limited upside potential.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact of whether the company confirms my investment thesis or not. Once the reasons (my investment thesis) of why I purchase shares of a company are not valid anymore, I sell and never look back.
Investment thesis
The company is already evolving to find other sources of revenue to stop being “the iPhone company”. Apple TV, iWatch, Apple Music, and Apple Pay are their most recent innovations. The company continues to offer a great product ecosystem and add more products that can connect to each other. This perfect ecosystem continues to attract more customers away from Androids to connect with Apple products.
Potential Risks
When you look at any “techno stock”, there is always a great risk. What is a premium product (the iPhone) today could become the next joke amongst geeks in the span of 12 months. It happened to BlackBerry (BBRY) and it could happen to Apple at any time.

AAPL shows a solid investment thesis and meet my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).
As previously mentioned in this analysis, AAPL shows a combination of both capital and dividend appreciation. While we are looking at a very solid company, AAPL still evolves in the technology sector. For this reason, AAPL stock could definitely go up or down rapidly upon shocking news. For this reason, I think AAPL would be a better fit in a growth portfolio than in a core one.
AAPL is a growth holding.

Final Thoughts on AAPL – Buy, Hold or Sell?

I’ve been a happy AAPL shareholder for many years now and I would not hesitate to enter into a new position if I was building another portfolio. AAPL is definitely a buy until it goes to a ridiculous value such as $200…
Disclaimer: I do hold AAPL in my DividendStocksRock portfolios.
 This article was written by Dividend Monk. If you enjoyed this article, please subscribe to my feed [RSS]

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