The surprising lure of big tech stocks: Dividends
The push is on for undervalued, cash-rich technology companies to return more money to investors. And there's still room for dividend growth.
By Constance Gustke, CNBC
Big, cash-rich technology companies are drawing intense scrutiny these days from frustrated shareholders and activist investors, but they also have found some new fans.
Take famed Oakmark Fund manager Bill Nygren. He thinks the market is undervaluing technology stocks — or, at least, looking at some of the bigger names through the wrong lens. They look a lot like the consumer product companies of the 1980s to Nygren, featuring moderate top-line growth and relatively inexpensive valuations. Intel (INTC), for example, is selling only at 11 times next year's earnings, Nygren noted. The technology industry is returning lots of capital to investors, too, and not just in the form of stock buybacks. "It's a good place to look for dividends," he said.
Though tech companies once viewed dividend payments with distaste, now companies are accelerating dividend policies. In 2010, the 32 dividend-paying stocks in the S&P 500 ($INX)information technology sector yielded 0.94 percent. By the end of 2013, that number had climbed to 44 stocks that yielded 1.63 percent, according to S&P IQ data.
Technology handily leads all other sectors in dividend growth. Apple (APPL), which began paying a dividend only a few years ago, is already the second-biggest dividend payer in the S&P 500 after Exxon Mobil (XOM) (measured by total dollars paid out to shareholders), according to Factset dividend data.
Analysts predict that tech-sector dividend payouts will continue increasing over the next year.
The 'debt-free' S&P 500 sector
The reason: Technology companies are becoming more comfortable offering — and increasing — dividends, said Scott Kessler, head of technology sector equity research at S&P IQ. They already have more money than they know what to do with — in fact, more cash and less debt than any other sector in the S&P 500.
During the financial crisis, large amounts of cash were a competitive advantage. A strong balance sheet was proof that a company could survive downturns, Kessler said. But times have changed.
Activist investors have helped moved the needle on dividends. Drawn by Apple's huge cash hoard, activist investor Carl Icahn has been urging the technology giant to pry open its deep pockets and return more money to investors. But Apple isn't the only target of outsiders agitating for higher dividend payments and share buybacks. Microsoft (MSFT), which has more than $77 billion on the books, was an activist investor target last year, too (Microsoft owns and publishes Top Stocks, an MSN Money site). And consumer rights legend Ralph Nader led a successful campaign to push Cisco Systems (CSCO) to increase its dividend.
Technology dividends are still fairly low compared to a traditional dividend-rich sector, like utilities. But that means there's still lots of room for dividend growth, said Diane Jaffee, portfolio manager of the TCW Dividend-Focused Fund. At year-end 2013, the technology sector's average payout ratio was only 20 percent of cash flow, compared to 36 percent for the S&P 500, she noted.
Jaffee's fund has been buying dividend-paying tech stocks, including Microsoft, Cisco, Intel and Microchip Technology (MCHP). For some tech giants, an increasing dividend profile is nothing new, but Jaffe is still betting on larger payouts. Intel has increased its dividend for 10 years and Microsoft for 12 years. "Some of these companies are now mature," Jaffee said, "but there's still growth there."
Jaffee favors tech stocks that pay dividends rather than reinvesting cash in stock buybacks. "We believe that dividends are incredibly important. They help make technology stocks less volatile," she said.
It pays to be boring
The downside? Tech stocks don't become dividend darlings without being seen by some as "over the hill." Many of the tech stocks that have increased dividends have been underperformers relative to the broader tech universe, so for an investor focused on technology sector growth, the dividend-rich stocks aren't the best play.
Google isn't pressured to dish out dividends, because it can still grow earnings rapidly. If Apple was still growing fast, nobody would care about its dividend, said Josh Peters, editor of the Morningstar Dividend Investor. "This is the process of carving up value," Peters said. "There's no reason that Apple should be sitting on that huge pile of cash." It currently totals more than $40 billion.
Technology companies are also new at paying dividends, and many lack solid dividend-paying track records. "They don't have long-term stability locked in," Peters said.
Indeed, not every investor buys into the idea that mature tech firms resemble mature consumer product companies. The fate of a company in the tech sector can change quickly, which makes relying on them for dividends a riskier bet than a traditional dividend sector play, said Soren Christensen, CEO of Advanced Wealth Advisors in Naples, Fla. Technology is still mostly a cyclical sector, and as a result, even if dividend-rich tech stocks look like blue chips, Christensen doesn't consider them to be true defensive plays.
"During downturns, these stocks will suffer," Christensen said, since they make products that people don't necessarily need. The technology sector is littered with companies like Nokia and BlackBerry that missed key consumer trends.
Barry Fennell, Lipper senior research analyst, countered that many tech stocks increasing dividend payouts are much more predictable than they were a decade ago when it comes to cash flow, revenue forecasts and expenses. Better visibility and above-average growth prospects relative to other traditional conservative sectors, such as chemicals, make a compelling case for the technology stock-dividend focus.
"It's a classic business model where the companies grew rapidly and then reached maturity and ... then you have to think they might become more of an automotive-type business, all about stealing or maintaining market share and holding on as long as they can," Fennell said.
And that's a thesis increasingly attractive to large mutual fund managers. "If you are comfortable with more predictable growth, tech stocks are certainly more attractive than most sectors in the S&P 500 right now dividend-wise," he added.
Some technology ETFs and tech mutual funds now even have yields higher than the S&P 500, a sign of how much dividends have increased in tech stocks, but the more cautious way to play the trend is probably the wise one.
"If you're an equity income–oriented investor, you need some exposure to the tech sector being 15 to 25 percent of S&P 500, and those companies will continue to pay out," Fennell said. "That would be the way to go."
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