Income investors have historically had few choices in the tech and Internet space when looking for equities with above-average dividend yields. In fact only 25% of the 231 stocks in these fields even pay dividends compared to 57% of the Value Line (Arithmetic) Index. The good news is more of these companies are choosing to boost returns for investors by initiating cash payments and raising existing yields.
The majority of tech companies have opted to boost total returns by increasing earnings through technical innovations and acquisitions in lieu of quarterly cash payments. Many management teams follow the notion that the more earnings they produce the less obligated they are to reward shareholders with dividends.
Taking a look at Value Line’s top 100 highest growth stocks, those companies included in the Computers/Peripherals, Computer Software/Services, E-Commerce, Electronics, Entertainment Tech., Foreign Electronics, Internet, Semiconductor, Telecom. Equipment, and Wireless Networking Industries currently paying dividends have had an average trailing ten-year annual growth rate of 14.7%, compared to a 23.1% rise in non-dividend paying tech stocks.
The highest growing, dividend paying tech stock included in the list, Oracle, (ORCL) has a yield of only 0.7% (half that of the average). That company started paying a dividend in April 2009, and recently upped its quarterly payout by 20%, to $0.06.
The dividend paying tech stock with the lowest trailing 10-year growth rate relative to our sample, Microsoft (MSFT - Free Microsoft Stock Report) also boasts the highest yield at 2.3%. That company averaged 21.5% annual dividend growth over the past five years, but the stock has languished due to weak presence in fast-growing markets.
Initially, Microsoft was reluctant to pay a dividend, much to the chagrin of political activist and former Presidential nominee, Ralph Nader, who claimed that executives were purposefully suppressing a payment in order to avoid the 39.6% tax rate that previously applied to income distributed as dividends. The Jobs and Growth Tax Relief Reconciliation Act of 2003 lowered the qualified dividend tax rate to 15% for those in the wealthiest tax bracket giving companies one less reason not to pay a dividend. This legislation has been extended twice and is set to expire at the end of 2012. Microsoft never acknowledged that Nader or the tax relief influenced the initiation decision; instead it said anti-trust litigation needed to be resolved before it was confident enough in its long-term financial position to pay a dividend.
Shares of Cisco Systems (CSCO - Free Cisco Stock Report) have fared considerably worse than the competition for the past several quarters, which we believe contributed to the recent initiation of a $0.06-a-share quarterly dividend yielding 1.4% annually. With the stock price down 32% in the past year amid weak government and consumer spending environments, corporate structure problems, increased price competition and a corresponding cut to its long-term revenue growth target, investors had been asking for more incentive to invest in the shares outside of capital appreciation potential and stock buybacks. Although the slowing growth likely provided an impetus for the dividend payment, it was probably inevitable considering Cisco’s massive $40.2 billion cash hoard.
Intel (INTC - Free Intel Stock Report) provides another example of a company with weak earnings growth rates that has recently increased its dividend. Over the past five years, Intel’s dividend payment has risen an average of 37.5% versus a 2.5% increase in earnings per share. Meanwhile, struggling phone maker Nokia (NOK) now has the second highest yield in the tech space with 6.6%.
International Business Machines (IBM - Free IBM Stock Report) is one exception to the high growth low dividend trend. It has been consistently increasing its dividend payout since 2003, even with an average earnings growth rate of 11% and an over 100% appreciation of its stock price.
Share repurchases have long been tech companies preferred method of returning cash to shareholders. Even though the dividend tax rate was lowered in 2003, share repurchases have no tax effect on shareowners and can raise earnings per share by a material amount each year. Management controls when and how many shares get bought so they can capitalize on cheap prices or not buy as much one quarter versus the next depending on capital requirements. This compares to dividends, which very rarely get suspended due to the negative financial strength assumptions their termination can generate among investors. Although companies routinely publicize repurchase activity, they often fail to mention that recent buybacks have only counteracted the dilutive effects of share based compensation, a practice that commonly gets overlooked by less savvy investors.
On the other hand, dividends can reassure investors of a company’s financial strength and that management is keeping shareholders interests in mind, not simply trying to line their own pockets. When tech darling Broadcom (BRCM) initiated a $0.08-a-share dividend in the March, 2010 quarter, it credited powerful cash flow generation, commitment to financial discipline, and the need to provide investors with an additional opportunity to earn a return on their investment. Furthermore, many mutual funds and pension accounts are forbidden from purchasing stocks without dividends, so adding a disbursement can entice new investors. Broadcom has since raised its dividend by a penny, to $0.09 a share, giving it a 0.2% yield.
Whether or not tech stocks are attracting income oriented portfolio managers is up for debate considering their average yield is 1.9% versus 2.4% for the dividend paying Value Line (Arithmetic) Index stocks and 6.0% for the top 95 dividend-yielding non-utility equities. Although the average tech issue may well dilute an income-focused portfolio, it will likely add diversification.
Despite the advantages that come with paying a dividend, some companies will probably continue to avoid doing so for the foreseeable future. Apple (AAPL) is a primary example. The company has exhibited extraordinary design prowess and marketing ability, permitting it to establish dominant positions in many of the markets it competes in, and has recorded a trailing 5-year earnings growth rate of 70%. For the quarter ended December 25, 2010, Apple had total cash, cash equivalents, and marketable securities (CDs, commercial paper, corporate securities, munis, U.S. agency securities) of $59.7 billion on its books (28% of the value of the gold in Fort Knox) accumulating an average of around one billion (1.5%) in interest per year. Apple is also expected to generate more than $20 billion in cash during fiscal 2011. Still, over the past three fiscal years the company has only made $858 million in acquisitions and $4.2 billion in capital expenditures ($2 billion more than it realized in depreciation and amortization expense). When Steve Jobs was asked what Apple’s plans were for the monies he said “We strongly believe that one or more very strategic opportunities may come along that we’re in a unique position to take advantage of because of our strong cash position.”
Although Apple probably won’t bend on its no-dividend policy, we believe dividend initiations and yield increases among many other tech and Internet companies will continue to rise as cash balances increase, established firms experience declining growth rates, and younger companies display discipline. This should create new ways for income-focused investors to diversify their portfolios and added incentives for growth-minded investors
At the time of this article's writing, the author did not have positions in any of the companies mentioned.