LONDON -- Many investors focus on earnings per share when judging a company's performance. However, earnings can be manipulated and adjusted in all sorts of ways, meaning they don't tell you a lot about how much spare cash a company has generated. Similarly, since dividend cover is calculated using earnings, a good level of dividend cover doesn't necessarily mean the payout is actually being funded from a company's profits.
A company's cash flow can tell you a lot about its financial health. Is the company burning up its cash reserves on interest payments and operating expenses, or does it generate spare cash that can fund dividends or be retained for future investment? If a dividend isn't funded by cash flow, then there is a greater chance the payout will become unaffordable and be cut, which is bad news for shareholders like you and me.
In this series, I'm going to take a look at the cash flow statements of some of the biggest companies in the world, to see whether their dividends are being funded in a sustainable way, from genuine spare cash. Today, I'm looking at tech giant Apple Inc. (NASDAQ:AAPL)
, which recently lost its crown as the world's largest company after its share price slid 10% in just one day, capping a 25% fall over the last three months.
Does Apple Inc. (NASDAQ:AAPL) have enough cash?
As private investors, we want to back businesses that are able to pay their dividends out of free cash flow each year. I define free cash flow as the cash that's left over after capital expenditure, interest payments and tax deductions. With that in mind, let's look at Apple Inc. (NASDAQ:AAPL
)'s cash flow from the last five years:
|Free cash flow
|Cash and marketable investments
Source: Apple annual reports. All figures in millions.
At first glance, Apple Inc. (NASDAQ:AAPL
)'s free cash flow doesn't look all that impressive. However, that's only because Apple generates so much free cash that most of it is siphoned off into a mixture of short and long-term investments, which are subtracted as part of the free cash flow calculation.
In its latest quarterly update, Apple revealed that its current cash pile -- composed of cash and "marketable securities" -- had reached $137 billion. That's a third of Apple's market capitalization, and begs the question of whether Apple should return a little more cash to its shareholders, since it is unlikely to ever be able to use it productively within the business.
Apple's dividend history
Until 1995, Apple was a regular dividend payer. When founder Steve Jobs returned to the company in 1996, he canceled the dividend, and Apple didn't pay a dividend again until 2012. The company's first payout for 17 years wasn't much of an effort, either -- the $2.65 per share payout equated to a dividend yield of just 0.5% at Apple's 2012 year-end share price of $509.
Luckily, this was only a starting point and so far in the current financial year (Apple's financial year starts at the end of September), Apple has declared $5.30 of dividends -- $2.65 per quarter -- suggesting that the full-year payout could be $10.60, providing a forward yield of 2.4% at the current share price of $450.
Apple's cash balance has grown rapidly over the last five years, highlighting the company's high profit margins and impressive ability to generate free cash flow. Despite this, the company's dividend is modest by the standards of mature tech stocks like Microsoft Corporation (NASDAQ:MSFT)
, which yields 3.3%, and Intel Corporation (NASDAQ:INTC)
, which yields 4.3%. Although Apple fans say that the company has more growth potential than either of these giants, the current share price suggests that many investors disagree. Apple currently trades on a price-to-earnings ratio of around 10 -- almost exactly the same as Intel. If you exclude Apple's cash, it trades on a P/E of just 7, suggesting that the market thinks it's a mature company, not a growth stock.