Ka-ching! Dividend investors live for that sound. Each quarter thousands of companies hand over their excess cash to investors. But not all dividend stocks are equal. In fact, some are straight up risky while others are extremely promising. So how do you find an excellent dividend stock? It’s simple. Look for companies with loads of cash. Case in point, Apple Inc. (NASDAQ:AAPL) — a dividend investor’s dream stock.
Two forms of cash
In business, cash comes in two forms: ongoing streams and accumulated hoards. Dividend investors want both.
Of the two forms of cash, the stream is the most important. Dividend investors should be able to rely on the company to throw off plenty of cash on an annual basis for years to come. Apple Inc. (NASDAQ:AAPL) passes on this front with flying colors. In each of the last five years (and the trailing 12 months), Apple turned more than $0.20 of every dollar of sales into free cash flow, or FCF.
Apple’s FCF-to-sales track record is impressive, handily qualifying the company as an authentic cash cow.
And as far as a cash hoard, Apple Inc. (NASDAQ:AAPL) delivers. Currently, cash accounts for 36% of its share price. This places Apple squarely at the top among other megacap tech stocks.
But having the most cash isn’t always a good thing — at least not if it’s just sitting there. In Apple’s case, the company has largely addressed this problem in two ways.
1. Apple Inc. (NASDAQ:AAPL) increased its dividend payout by 15% and promised to review its dividend annually.
2. The company announced a major boost to its share repurchase program, committing to buy back $60 billion in shares by the end of 2015 compared to its previous commitment of just $10 billion.
Yes, Apple Inc. (NASDAQ:AAPL)’s dividend yield is substantially lower than other popular dividend stocks like Waste Management, Inc. (NYSE:WM), with a whopping 3.5% yield. So what makes Apple better than stocks like Waste Management? Why not Microsoft Corporation (NASDAQ:MSFT), with a FCF-to-sales ratio of 36% (1,000 basis points higher than Apple’s) and a nearly identical dividend yield?
Apple Inc. (NASDAQ:AAPL)’s massive cash hoard aside, the pivotal difference is Apple’s payout ratio. Payout ratio is defined by a company’s dividend as a percentage of its earnings. The higher the ratio, the less sustainable the dividend if things go awry. The lower the ratio, the more sustainable the dividend, and the more room for the company to increase the dividend.