A case study: Apple vs. Verizon

Many investors look at dividends as the main form of return that they can expect from owning stocks. And when you look at Verizon’s 5.2% dividend yield vs. Apple’s 1.7% yield, you might think that Verizon offers shareholders better returns.

But dividends aren’t the only form of shareholder returns on capital. And how those returns are funded matters greatly.

Paying a dividend is simply returning cash to shareholders. As a shareholder, you already own a claim on the cash. The dividend just puts that cash in your pocket–and makes you pay taxes for the right to have it.

Another form of shareholder return is a share repurchase. This is when the company buys its own stock and retires those shares, reducing the total amount of shares outstanding. This reduction makes all the remaining shares more valuable–since the remaining shareholders own more of the company. 

Verizon made no share repurchases last year, mostly because they can’t afford to do so. Whereas Apple has repurchased enough shares to reduce the share count by 4.8%. When you combine Apple’s dividend with its share repurchase, Apple shareholders are effectively receiving a 6.5% yield. 

But how safe is Verizon’s dividend? And how reliable are Apple’s share repurchases? Let’s compare:

Verizon spent about 77% of its cash earnings on buying new equipment. And it spent 40% of its cash earnings on the dividend. Some quick math shows that Verizon spent more than 100% of its cash earnings between the two. How could it spend more than it earned? By borrowing money of course. Verizon has about $120 billion in debt, and has been a reliable credit, but there are always limits to borrowing money. In a pinch, the dividend may need to be cut.

Now take Apple. They spent 20% of their cash earnings on new equipment. The dividend amounts to 19% of their cash earnings. So Apple has a lot of flexibility in what they can do with the remaining 60% of their annual cash earnings. And because Apple is such a great cash generating machine, the cash has been piling up. Whereas Verizon has more debt than cash to the tune of $120 billion, Apple has a net cash balance of $158 billion. 

To sum up: Verizon needs to spend all the cash it makes and then some, and they’ve piled up a large amount of debt, which increases each year. Apple generates more cash than it needs and has a growing mountain of cash. 

If you were to be put in charge as the owner-operator of one of these two businesses, which would you choose? 

Best regards,

Evan McGoff

 

Disclosure: Dock Street Asset Management, Inc. and/or our clients may own Apple (APPL) and Verizon (VZ). This article is not intended to be used as investment advice.