History Indicates Apple Is Going to Disappoint Income Investors

Apple is due to update its capital allocation program later this month, close to the company's quarterly earnings release, which is due April 27. Expectations are very high, since Apple is enjoying record results. Thanks in large part to the debut of the iPhone 6, as well as its budding partnership with China Mobile , the largest wireless carrier in the world, Apple registered huge growth over the past year.

iPhone 6 and iPhone 6 Plus. Source: Apple website.

One topic Apple will likely address is its dividend. Apple reinstated its dividend in 2012 and, as fellow Fool Daniel Sparks related,has increased its payout two times since, by about 15% in 2013 and about 8% in 2014. It has now been four quarters since Apple last increased its dividend, which means another raise is likely. But before investors get too excited, there is a strong chance Apple will deliver an underwhelming dividend bump. Here's why.

Apple's cash "problem"Apple generated $30 billion of free cash flow last quarter. In the same period, the company paid $2.8 billion in dividends to shareholders. This equates to a minuscule 9% free cash flow payout ratio.

At its recent closing price of $126 per share, Apple stock offers just a 1.5% dividend yield. This is below the broader market yield. The S&P 500 Index, on average, yields about 2%. Apple's dividend yield has fallen significantly over the past year, as its tiny dividend increases have not kept up with its soaring stock price. With an enormous amount of cash at its disposal, this should give the company more than enough room to increase the dividend by a huge amount later this month.

AAPL data by YCharts.

Since Apple is racking up huge growth with little capital expenditure requirements, the cash is really piling up. At the end of last quarter, Apple held $177 billion in cash and marketable investments on its balance sheet. The problem is, it's also true that the majority of this cash is held overseas. According to a recent article in Forbes, Apple holds 89% of its cash outside the United States.

Apple would face a hefty tax if it were to bring that cash back to the United States to, for instance, pay dividends, making repatriation unlikely. As a result, Apple faces a unique problem, which is that its own cash is very difficult to get to. Normally, under these circumstances, a company could simply access the debt markets. Particularly for a company with as much cash as Apple, it could easily leverage its balance sheet by issuing debt to raise the necessary cash. And, Apple has done just that.

Apple's long-term debt has doubled in the past year. At the end of last quarter, long-term debt stood at $32 billion, up from $16 billion in the same quarter the year before. In fact, Apple didn't have any long-term debt at all as recently as the second quarter of 2013. Management may not have an appetite to continue raising debt at such an aggressive pace, though.

Furthermore, even if management did continue to tap the debt markets, Apple has shown a large preference for using the proceeds for share buybacks rather than dividends. Over the past year, Apple returned a total of $57 billion to investors through combined dividends and share buybacks. But of this, only $11.2 billion was used for dividends. The remaining $45.8 billion, or approximately 80% of its capital return program, was utilized for share repurchases.

Expect another modest dividend increaseThe vast majority of Apple's cash is overseas, and the company greatly prefers to return cash via share buybacks. These were the reasons Apple's 2014 dividend increase was a puzzling 8%. This was a very small increase for a company that has a single-digit free cash flow payout ratio and a mountain of cash on its hands.

Apple has set a precedent for its capital allocation priorities and this sets the stage for another tepid dividend increase, which may alienate income investors.

In order to make its dividend more competitive, Apple would need to pass along a very generous increase. A 25% dividend raise would still only lift its current yield to 1.8%, which would fall below the stock market average.

I don't envision the company raising its dividend enough to make it a truly competitive dividend stock.

The article History Indicates Apple Is Going to Disappoint Income Investors originally appeared on Fool.com.

Bob Ciura owns shares of Apple. The Motley Fool recommends Apple and China Mobile. The Motley Fool owns shares of Apple. 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.

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