Apple is very likely to become a future dividend aristocrat.

Apple's stock has fallen 11% year-to-date as investors grapple with a series of headwinds such as unprecedented inflation levels, rising interest rates, and the war in Ukraine.

Those who only focus on the short term may overlook a key detail about the company: in the technology industry, and perhaps even the entire market, Apple has one of the safest dividends.

Apple's business generates significant profits and free cash flow, supporting the growing dividends. Such companies should be the cornerstone of dividend growth investors' portfolios.

This article will examine this company to see why I believe Apple is a future dividend aristocrat, despite it being more than ten years away from the dividend growth years needed to enter this exclusive group.

Company background and performance history

Apple initially started as a computer company, but has now evolved into a leading supplier of various personal technology devices. This $2.6 trillion company created $378 billion in revenue last year.

In an industry full of revolutionary companies, Apple has always been one of the most successful names in history. The company's product lineup includes iPhone, Mac, iPad, iPod, Apple Watch, and Apple TV.

Apple has a services business selling applications, music, and subscriptions. Additionally, the company offers consumers a way to complete financial transactions through its Apple Pay digital wallet service.

Once customers generate income through personal computers, they can use a variety of Apple products to create a complete ecosystem for themselves. The company's products are widely regarded as industry leaders. As they can interconnect, they can be used together to enhance user experience.

Apple's product lineup has made it one of the most successful companies in history. The top and bottom line performance reflect this success.

Over the past 10 fiscal years, the compound annual growth rate of revenue has been close to 10% (the company's fiscal year ends on the last Saturday of September).

During this period, the compound annual growth rate of earnings per share is 15.1% as Apple has significantly reduced its share count over the years. Over the past decade, the company has bought back nearly 5% of its shares annually.

Since the 2012 fiscal year, net income has continued to grow at a rate of 9.5% annually. Over the past decade, the profit margin has remained relatively stable, so the growth in net income is driven by higher sales.

Although the long-term data is strong, what should excite investors is the recent performance. Looking only at the past five years, the compound annual growth rate of revenue is 12.4%. Over the past five years, earnings per share have also grown at a rate of 25% per year, to some extent thanks to share buybacks. Net income grows by over 18% annually, with a net profit margin increase of 480 basis points to 25.9%.

Although Apple has achieved long-term success, it has indeed made significant progress in the past few years, with accelerated growth in revenue, earnings per share, and net income. The company is simply selling more products and extracting more profit from its business.

Companies in long-term growth mode usually do not see accelerating fundamentals. It becomes increasingly difficult to maintain a high growth rate when starting from a higher base.

Apple is one of the few companies that have successfully achieved this goal, and the company will pay out increasingly more dividends.

Performance in a recession and dividend growth history

Growth companies in the technology industry often perform poorly in a recession, but as the previous section shows, Apple is different from most companies.

Adjusted for stock splits, the total earnings per share for Apple before, during, and after the Great Recession are as follows:

Earnings Per Share adjusted for 2006: 8 cents

Adjusted earnings per share in 2007: 14 cents (up 75%)

Adjusted earnings per share in 2008: 19 cents (up 35.7%)

Adjusted earnings per share in 2009: 22 cents (up 15.8%)

Adjusted earnings per share in 2010: 54 cents (up 145.5%)

Adjusted earnings per share in 2011: 99 cents (up 83.3%)

Adjusted earnings per share in 2012: $1.58 (up 59.6%)

Apple's earnings grew by over 57% between 2007 and 2009. Some may point out that a slowdown in growth over time is a negative sign for the company, but Apple immediately returned to high growth mode after seeing a decline in the rearview mirror. What makes this growth even more impressive is that it was largely achieved without share buybacks, as the company maintained a stable number of shares until 2013.

For a recent example of the company's performance under adverse conditions, consider the COVID-19 pandemic. In the 2020 fiscal year, which covered most of the severe pandemic period, Apple's revenue, net income, and earnings per share increased by 5.5%, 3.9%, and 10.4%, respectively. The business did slow down, but more importantly, there was indeed growth even in a highly challenging period. In the very next year, due to a significant rebound in the business from the previous year, revenue, net income, and earnings per share increased by 33.3%, 64.9%, and 71%.

Apple did not pay dividends during the last economic downturn, but started paying dividends for the first time in 2012. The company has now maintained a streak for nine years. Since 2013, dividends have more than doubled, with a compound annual growth rate of 9.5% during this period. The five-year CAGR is 9%, showing investors that the company's dividend growth has been fairly consistent during these two periods. The company's most recent increase last year was 7.3%, still close to the long-term average level.

Coupled with significant share buybacks, Apple has always been a very shareholder-friendly company.

The impact of dividend yield and debt on future dividend growth

Apple's business is a profit and free cash flow generating machine. This is why buybacks and dividend growth have been so significant over the years.

In the 2021 fiscal year, Apple paid a dividend of 85 cents per share, generating earnings of $5.61 per share with a payout ratio of 15%. Investors should expect to see at least an 88 cent dividend per share this year. Analysts predict an earnings per share of $6.17 for the company, with an estimated dividend rate of 14% for the 2022 fiscal year. Apple's average payout rate has been 24% since 2012. The expected payout rates for last year and this year are significantly lower than the already very low long-term average level.

Let's consider free cash flow. The company distributed $14.5 billion of free cash flow in the last fiscal year, while generating nearly $93 billion of free cash flow, with a free cash flow payout ratio of 16%. Over the past three years, the average free cash flow payout ratio has been 21%. Similarly, the recent ratio is lower than the average level.

Finally, let's take a look at the company's debt to better understand how its debt affects future dividend growth.

The company's interest expense for the most recent fiscal year was $2.6 billion. The total debt is 124.7 billion Australian dollars, equivalent to a weighted average interest rate of only 2.1%.

The table below shows where Apple's weighted average rate needs to be before dividends cannot be solely paid by free cash flow.

Before free cash flow can cover dividends, Apple's weighted average rate needs to exceed 65%.

For a company of Apple's scale, with a very low payout ratio and highly manageable debt levels, it is unlikely that the company would not continue to increase dividends.

Final Thoughts

Dividend aristocrats often have entrenched business models that generate sufficient profit and free cash flow to pay growing dividends. These companies typically offer products and services that consumers need, even during economic downturns. They must also have management teams willing to return capital to shareholders.

Apple checks all these boxes and more. The company's ecosystem allows customers to use multiple products simultaneously, enhancing the user experience. This helps create loyal followers among many of Apple's customers.

Long-term, almost all indicators show strong growth rates, with most indicators (if not all) accelerating in the short term.

Apple's capital return is very lucrative. The company achieves this due to the amount of capital it generates, resulting in very low yields and free cash flow payout ratios. Given the free cash flow the company generates, debt is also unlikely to impact dividend growth.

Taken together, these features may one day make Apple a dividend aristocrat.

Purely fictional