An Apple Dividend Could Be Sweet Indeed

02/01/2012 12:15 pm EST

Focus: INCOME

John Heinzl

Reporter and Columnist, GlobeInvestor.com

Initiating a dividend signals a healthy company and lures new investors. Just look at some of these other success stories, writes John Heinzl, reporter and columnist for Globe Investor.

How will Apple’s (AAPL) stock react if the company initiates a dividend? For a clue, look at Starbucks (SBUX), Cisco Systems (CSCO), Dollarama (Toronto: DOL), and Lexmark International (LXK).

All of these companies initiated a dividend within the past two years, and in each case the stock is higher now than it was when the payment was declared. The gains range from about 13% for Lexmark, which announced its first dividend in October, to 91% for Starbucks, which initiated a dividend in March 2010.

Not every company that initiates a dividend goes on to post double-digit gains, of course. And there are no guarantees that Apple’s high-flying stock will keep rising if—as a growing number of analysts expect—it shells out some of the nearly $100 billion in cash on its balance sheet.

But a dividend initiation is often a bullish signal, partly because of what it says about management’s outlook, and also because it brings new investors into a stock.

"The paying of a dividend reflects tangible evidence of the underlying financial strength of a company," said Charles Carlson, chief executive officer of Horizon Investment Services in Hammond, Indiana, and author of The Little Book of Big Dividends.

"Once a company initiates a dividend, it doesn’t want to cut it two quarters later. So there’s a confidence factor that the company is going to be able to continue to generate the cash flow needed to support that dividend."

In most cases, investors expect that the company won’t just maintain the dividend, but will raise it.

Starbucks, for example, initially paid a quarterly dividend of ten cents a share. Less than four months later, it hiked its dividend by 30%, and in November it announced another increase of 31%. Starbucks’ stock price has followed the dividend higher, richly rewarding investors who jumped in after the first dividend was declared.

The dividend, per se, doesn’t necessarily drive the stock up. Rather, it’s what the dividend signals about the health of the company and management’s growth expectations. Sometimes it takes a while for the stock to react to the improving fundamentals that a dividend declaration reflects.

"Do the shares react immediately? The answer is, not necessarily," said George Vasic, chief economist and equity strategist at UBS Securities Canada in Toronto.

For some companies, such as gold and silver producers, investors don’t buy the stock for the dividend, which is typically puny. So a dividend hike usually doesn’t have much impact on the share price.

With industrial or consumer-oriented stocks, on the other hand, a dividend initiation could attract income-oriented funds and other investors that otherwise wouldn’t be interested in the company. That extra demand pushes up the price.

"Income and dividend funds are seeing all the inflows [of investor cash] for the last several years, and that could be positive in terms of attracting new investors" to a company, Vasic said.

Shares of Canadian discount retailer Dollarama, for instance, have surged about 35% since it initiated a small dividend last June. Fellow Canadian chain Tim Hortons (Toronto: THI) has soared 73% since initiating a dividend in 2006, and the company has raised its dividend four times, with a fifth increase expected in February.

Apart from Apple, cash-rich US companies that could initiate a dividend include Google (GOOG), Berkshire Hathaway (BRK.B), and Amazon (AMZN). Other companies with modest dividend yields, such as Walmart (WMT) and Microsoft (MSFT), are in a position to hike their payments substantially, analysts say.

Consumer advocate Ralph Nader, a Cisco shareholder, has gone public with demands that Cisco reduce share buybacks and instead more than double its quarterly dividend and pay a $1 special dividend.

"Most studies show that company buybacks have not increased shareholder value…" he wrote. "Other data [have] convincingly shown over the last 40 years that dividend-paying stocks are better for shareholder appreciation than non-dividend-paying companies."

With corporate cash at record levels and more investors agitating for companies to share the wealth, dividends are bound to rise in the next few years.

"The payout ratio [dividends as a percentage of profits] in this country is around 30%. It historically was between 40 and 50%," said Daniel Peris, a dividend-fund manager at Federated Investors in Pittsburgh and author of The Strategic Dividend Investor. "It’s been abnormally low and…it really has to go further up."

Some companies are getting the message. On Tuesday, toy giant Mattel (MAT) boosted its quarterly dividend by 35% after reporting fourth-quarter profits that beat Wall Street estimates.

Still, not everyone is convinced Apple will initiate a regular quarterly dividend. Carlson thinks the company might start with a special one-time dividend of about 1%, or $4 to $5 a share. That would placate investors who want the company to give back some of its cash, but would give Apple greater flexibility than if it started a regular quarterly payment.

It’s more likely that Google, which is coming off a disappointing quarter, will initiate a regular dividend in an attempt to boost its sagging stock price, he said.

Google "may be at a point where they may be looking to broaden the buyer market for their stock, more so than Apple," Carlson said. "Apple stock certainly hasn’t been penalized at all by not offering a dividend."

Related Articles on INCOME