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Apple: The Ultimate Dividend Stock?

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I get it. "Shares Slide on Demand Worries... Apple (NASDAQ: AAPL) Dips Below $500." I woke up this morning to repetitive, bearish Apple headlines. But thanks to Wall Street's shortsightedness, there is a deeper story here. At these levels, Apple is turning into the ultimate dividend stock.

There are three things income investors look for to identify solid dividend investments:

  1. A nice yield
  2. Pricing power
  3. A relatively low payout ratio

Investors need to stop thinking of Apple as a growth investment. Even I've been slow to adjust my thesis, evident by my ridiculous, overly bullish outlook for Apple last year.

Since then I've tamed my bullish thesis, but I still firmly believe Apple shares are undervalued for the long-term investor. In fact, there really is no bearish story to Apple's fundamentals. Apple just has some tough expectations to live up to. Face it: Apple has to go up against some incredible comparisons. In FQ1 2012 Apple's growth was phenomenal:

  • Revenue was up 73%
  • Mac sales were up 26%
  • Asia/Pacific mac sales were up 58%
  • iPhone sales were up 128%
  • iPad sales were up 111%
  • Net income increased 118%
  • Gross margin was 44.7% (compared to 38.5%)

Apple reports FQ1 2013 results on Jan. 23. Tough luck, Apple.

But Apple investors shouldn't fret. And if you are considering buying Apple, do it. At today's price, you can lock in a great dividend yield for years to come.

Valuation by Comparison: Einhorn's Favorite Dividend Stocks

David Einhorn's Greenlight Capital, famous for shorting Lehman Brothers prior to the 2008 collapse, turned $900 million into $6 billion in just 12 years. Below, I'll compare four of Einhorn's favorite dividend investments to Apple to see how Apple measures up.

<table> <tbody> <tr> <td>Company</td> <td>Dividend Yield</td> <td>Payout Ratio</td> <td>FCF-to-Sales</td> </tr> <tr> <td><strong>Seagate Technology</strong> <span class="ticker" data-id="220462">(NASDAQ: <a href="http://caps.fool.com/Ticker/STX.aspx">STX</a>)</span></td> <td>4.59%</td> <td>13%</td> <td>22.4%</td> </tr> </tbody> </table>

This hard disk designer and manufacturer has all the characteristics of a great dividend stock: a nice dividend yield, a somewhat low payout ratio, and a clear ability to turn sales into cash, with a free cash flow-to-sales ratio of 22.4%. Payout ratio is calculated as the fraction of net income a company pays to investors in dividends. The lower this ratio, the more sustainable the dividend if things go awry. A 13% payout ratio, therefore, isn't bad. Seagate's significant 22.4% FCF-to-sales ratio is evidence of the firm's pricing power, which should help the firm continue to throw off cash going forward.

<table> <tbody> <tr> <td>Company</td> <td>Dividend Yield</td> <td>Payout Ratio</td> <td>FCF-to-Sales</td> </tr> <tr> <td><strong>Ensco</strong> <span class="ticker" data-id="203424">(NYSE: <a href="http://caps.fool.com/Ticker/ESV.aspx">ESV</a>)</span></td> <td>2.45%</td> <td>29%</td> <td>5.9%*</td> </tr> </tbody> </table>

* Due to irregularities in Ensco's FCF, I used a six-year average

Ensco's dividend yield may be the lowest of the bunch (with the exception of Apple), but it also enjoys the greatest growth story, with a P/E of 12 and a forward P/E of 7.5. So investors should expect continual increases in the dividend. But the firm's payout ratio, at 29%, isn't excellent. Even worse is the firm's pricing power, with a FCF-to-sales ratio of just 5.9%

<table> <tbody> <tr> <td>Company</td> <td>Dividend Yield</td> <td>Payout Ratio</td> <td>FCF-to-Sales</td> </tr> <tr> <td><strong>Microsoft</strong> <span class="ticker" data-id="204577">(NASDAQ: <a href="http://caps.fool.com/Ticker/MSFT.aspx">MSFT</a>)</span></td> <td>3.45%</td> <td>43%</td> <td>40.3%</td> </tr> </tbody> </table>

Microsoft is a very profitable company. Thanks to the huge gross profit margins enjoyed by its Windows and Microsoft Office divisions, which make up over 50% of the company's revenue, Microsoft manages to consistently turn a whopping 40% of sales into free cash flow -- clear evidence of the firm's pricing power. The payout ratio of 43% is significantly high, but Microsoft's 3.45% dividend yield should continue for years to come considering the company's ability to throw off cash.

<table> <tbody> <tr> <td>Company</td> <td>Dividend Yield</td> <td>Payout Ratio</td> <td>FCF-to-Sales</td> </tr> <tr> <td><strong>Einstein Noah Restaurant Group</strong> <span class="ticker" data-id="210292">(NASDAQ: <a href="http://caps.fool.com/Ticker/BAGL.aspx">BAGL</a>)</span></td> <td>3.94%</td> <td>54%</td> <td>5.7%</td> </tr> </tbody> </table>

Thanks to a recent sell-off after a $4 special dividend payout, Einstein Noah enjoys a significant dividend yield of 3.94%. But in the highly competitive restaurant business with low barriers to entry, the company has a very low FCF-to-sales ratio of just 5.7%. Also, the firm's payout ratio of 54% is high enough to merit some concern in the reliability of the dividend if the future isn't as rosy as management predicts. But management displayed clear confidence in the firm's ability to pay out dividends when it issued a $4 special dividend in December.

<table> <tbody> <tr> <td>Company</td> <td>Dividend Yield</td> <td>Payout Ratio</td> <td>FCF-to-Sales</td> </tr> <tr> <td>Apple</td> <td>2.1%</td> <td>6%</td> <td>26.5%</td> </tr> </tbody> </table>

Apple has the lowest dividend yield of the four stocks above, at 2.1%. But the company has undeniable pricing power, evident by the company's 26.5% FCF-to-sales ratio. Yes the ratio is lower than Microsoft's, but Microsoft isn't a hardware company; Apple stands alone in the consumer electronics/hardware industry with by far the highest FCF-to-sales ratio.

Apple's premium products clearly have significant pricing power. In response to rumors that Apple would sacrifice quality for market share in a cheaper phone, Phil Schiller responded with conviction: "Despite the popularity of cheap smartphones, this will never be the future of Apple's products. In fact, although Apple's market share of smartphones is just about 20%, we own the 75% of the profit." 20% market share and 75% of profits -- this pricing power is evidence of the durable competitive advantage that should keep cash flowing for years.

Finally, and best of all, Apple's payout ratio is a paltry 6%. Even if Apple's margins suffer by a few percentage points in 2013 and growth comes in flat, Apple could easily double its dividend without causing significant disruption to the firm's operations. After all, why should tens of billions of dollars lay dormant?

If Apple doesn't increase their dividend in 2013 it's mostly likely because the are enjoying continued growth; the company still has several potentially significant growth drivers.

The Bottom Line

I don't know what price Apple will trade at tomorrow, next month, or even next year (If you know, please let me know in the comments below). But I do know one thing: Apple is a great dividend stock for the long term investor -- especially at today's price, hovering around $500 per share.

Oh, and did I mention that Apple is Einhorn's largest holding?

Case closed.

DanielSparks has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Microsoft. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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