Apple: Dividend or Buyback?

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

Earlier this week Moody's projected Apple's (NASDAQ: AAPL) cash pile could top $170 billion by the end of this year. Predictably, this reignited calls for that cash to be paid back to shareholders in the form of a dividend or share buyback.

What's the best way to return investors' capital? Here're five factors to consider. 

Flexibility

Dividends are sticky.

Once a company issues a dividend, management becomes reluctant to change their policy. This is fine for utility or pipeline companies as these industries are stable. But stickiness is a problem in fast-moving sectors like technology. A dividend creates a fixed obligation that could hurt Apple during the next industry shift. 

Maybe Android will takeover the smartphone space

Could Apple discover a productive use for its cash?

Perhaps BlackBerry will make a comeback.

It's difficult to tell what the technology landscape will look like five years from now. By choosing a buyback program, management retains flexibility if they need to conserve cash. Cutting the dividend is a more difficult proposition. 

Advantage: Buyback

Convention

What are other companies doing?

Traditionally high-tech firms avoided returning capital to shareholders because it signaled the company had run out of innovative ideas. But with cash balances growing faster than it can be redeployed, that perception is changing. Across the industry, technology executives are opting for both buybacks and dividends.

Qualcomm (NASDAQ: QCOM) is making an effort to return $13 billion in cash that is piling up on its balance sheet. Earlier this month the company announced it will hike its dividend 40% and initiate a $5 billion share buyback program. This will increase the yield on the stock from 1.55% to 2.17%.

Microsoft (NASDAQ: MSFT) is sitting on $68 billion and generating $31.6 billion in operating cash flow annually. With a shortage of productive projects, the company have chosen to pay shareholders both $6.4 billion in dividends and $3.1 billion in share buybacks over the past year.  

Advantage: Draw

Taxes

Dividends are heavily taxed. 

On Jan. 1, Congress raised the dividend tax rate to 20% on households earning more than $400,000 or $450,000 for married couples. By comparison, capital gains are only taxed at 15%. 

Investors can also choose to delay their tax liability with a buyback as long as they hold their shares. But investors are forced to pay taxes immediately with a dividend. 

Advantage: Buyback

Valuation

Is the stock cheap?

Share buybacks have a bad reputation. Between 2004 and 2011, members of the S&P 500 bought back a combined $2.7 trillion in stock squandering billions of dollars in shareholder wealth by purchasing overpriced shares

But is this the case with Apple? There's a perception the stock is undervalued. Shares are trading below 10 times trailing earnings and the company is priced at a discount to industry peers on every metric. After backing out the cash on the company's balance sheet, the market is valuing Apple's entire business for less than seven times trailing earnings. By buying back stock, shareholders would be increasing their stake in a undervalued business. 

Advantage: Buyback

Shareholders

What do shareholders want?

Apple is still a growth stock. Most shareholders are aggressive investors looking for capital gains rather than utility-like dividends. 

This may be changing. Since Apple announced its first dividend last year, it has attracted legions of yield-hungry investors who would like nothing more than a steady stream of checks into their brokerage accounts. Arguably through, these types of investors are a bad fit for Apple, which operates in a rapidly changing and volatile industry. Increasing the dividend would only increase the mismatch in the type of shareholders that are suitable to hold Apple stock.  

Advantage: Buyback

Foolish bottom line

The evidence is clear. Buybacks are the best way to return capital to Apple shareholders. 


Robert Baillieul has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple, Microsoft, and Qualcomm. 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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