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How to Play It: A dividend strategy with Apple in mind

By David K. Randall

NEW YORK (Reuters) - Apple isn't the only prominent company that analysts have tagged as a potential source of dividend payouts. Investors can target the sweet spot of reliable income and share price gains by buying companies that are likely to initiate or increase dividends.

With nearly $100 billion in cash on its balance sheet, Apple will initiate a dividend and share buyback that will total $45 billion over three years.

A quarterly dividend of $2.65 per share will begin in July, marking Apple's first such payout since 1995.

It's a move that many institutional investors have been expecting. Apple increased its earnings per share by 83 percent in 2011, but its shares traded at price-to-earnings multiples more in line with industries like railroads or grocery stores than innovative technology businesses.

Apple's huge cash pile was one reason for its low P-E, because investors were acting as if shareholders would never see the benefit of that cash.

Here, then, are suggestions on how to build a dividend strategy with Apple in mind:

OTHER TECH COMPANIES

Analysts expect Apple's large technology peers to follow the leader and boost their dividend payouts.

"If anybody can make dividends cool, it's Apple," said Christopher Davis, a fund analyst at Morningstar who covers dividend funds.

With higher-than-average cash levels on their balance sheets and strong brand names, many tech companies look more like classic value companies than the go-go growth stocks of the late 1990s. Those cheap valuations may help these giant tech companies sustain share gains even if the market rally fizzles.

Microsoft pays a dividend with a yield of 2.4 percent, while Cisco Systems pays a dividend yield of 1.6 percent. Higher dividends would make these large-cap technology companies even more attractive to fund managers and other institutional investors, analysts say.

And more dividend initiations could be coming out of Silicon Valley. With Apple set to pay a dividend with a yield of 1.8 percent, Google now becomes one of the largest tech companies that does not offer a payout. The company has some $45 billion in cash and is trading at a price-to-book value of 3.5, well below Apple's 7.1 price-to-book value.

"Digesting the pending acquisition of Motorola Mobility will keep them occupied for now, but longer term Google's core business is a strong cash generator, and a dividend would be one way to put that cash to work," said Daniel Ernst, an analyst at Hudson Square Research in New York.

A technology-focused ETF could be another way to play possible dividend increases in the sector. The $9.5 billion Technology Select SPDR, for example, is top heavy with dividend payers Apple, Microsoft, International Business Machines and AT&T accounting for 41 percent of the fund's assets. Google is the fifth-largest holding at 5.3 percent.

The fund, which costs 18 cents per $100 invested, yields 1.33 percent.

GROWING DIVIDEND FUNDS

The volatility in the stock market last year made dividend strategies increasingly popular. Dividend-focused funds and ETFs collectively had $17.3 billion in inflows last year, despite a broader investor push away from equity funds, according to Morningstar data.

It's a trend that shows few signs of letting up, despite a new risk: the end of low tax rates on dividends. Dividend income tax rules are set to revert to the pre-George W. Bush era, which means dividends will be taxed at ordinary income rates of up to 39.6 percent. The tax is currently 15 percent.

Investors who focus on dividends argue that they are a sign of a strong balance sheet and a proven business model. Classic dividend payers like Johnson & Johnson and Exxon Mobil tend to hold their value during volatile markets because of the payouts, said Linda Duessel, a senior equity strategist at Federated Investors specializing in equity income.

What's more, many blue chip companies pay higher dividends than 10-year Treasurys, which currently yield about 2.4 percent. While these stocks come with more risks than U.S. bonds, their large cash positions are attractive to income-seeking investors.

The $9.6 billion Vanguard Dividend Growth fund is one way to target companies upping their shareholder payouts. It yields 1.9 percent and costs 34 cents per $100 invested. Automatic Data Processing, Occidental Petroleum and PepsiCo are among its largest holdings.

Be prepared for the fund to lag the market during rallies like the current one. The fund is up 7.1 percent so far this year, which is five percentage points behind the broad S&P 500 index.

Its long-term performance is better, however. The fund is up an annualized 5.6 percent over the last 10 years, or 1.7 percentage points above the S&P 500.

(This story was refiled to additional subscribers)

(Reporting By David Randall; Editing by Jennifer Merritt and Steve Orlofsky)

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