As tech companies report their earnings in the next few weeks, investors will be paying attention not only to growth metrics and product development but also their common stock dividends.
Technology stocks aren’t traditional dividend havens the way utilities, consumer staples, and other sectors have been. But that’s shifting as companies such as Microsoft (MSFT) and Cisco Systems (CSCO) operate mature businesses that throw off excess cash.
“Many of these companies have the qualities that are important to dividend investors in that they have strong balance sheets, generate high levels of free cash flow, are growing revenues, and often have relatively low payout ratios,” says Mark Freeman, chief investment officer at Socorro Asset Management in Dallas.
Valuations are stretched for many utilities and consumer-staples stocks, he notes, and he expects “the tech sector will become a larger part of dividend investors’ portfolios.”
A quick scan of equity-income mutual funds reveals some common tech names among the top holdings, notably Microsoft, which started paying a dividend in 2003, and Apple (AAPL), which resumed its dividend in 2012 after suspending it in 1996.
“It’s been a balancing act for these legacy tech stalwarts in terms of dividends and giving money back to shareholders—but then making sure they are investing in their businesses, whether it’s M&A or capex,” says Dan Ives, a tech-stock analyst at Wedbush. “They are trying to appease many different facets of shareholders.”
Neither stock has a big yield. Microsoft’s was recently at 1.3%, and Apple’s was at 1.5%—the lowest among the eight tech companies included in the accompanying table.
Both companies generate a lot of cash. At the end of Apple’s fiscal second quarter in March, for instance, it had $225 billion of cash plus marketable securities. Subtracting debt, its net cash totaled nearly $113 billion.
In late April, Apple declared a quarterly dividend of 77 cents a share, up 5% from 73 cents. It has raised its payout every year since 2013.
Meanwhile, Microsoft boosted its quarterly payout last September to 46 cents a share, a nearly 10% increase from 42 cents. In its fiscal fourth quarter, ended June 30, it spent $3.5 billion on common stock dividends, up 9% from a year earlier.
“We’re OK with the idea that you can play tech for the dividends, but you have to be much more selective today,” says David Katz, chief investment officer at Matrix Asset Advisors in White Plains, N.Y.
For one thing, tech stock yields have fallen as share prices have gone up. The S&P 500 index’s (.SPX) technology sector had a total return of 32.6% this year, tops among the 11 sectors.
Katz says his firm has done well with tech holdings such as Microsoft, Cisco Systems, and Qualcomm (QCOM), all of which pay dividends and have returned more than 30% over the past 12 months.
“But we are less enthusiastic, simply because they have had such a great move,” he says.
In early 2015, Microsoft’s yield was close to 3%, but it has shrunk considerably as the stock price has appreciated.
The company, traditionally reliant on software, has made a strong push into cloud computing with its Microsoft Azure service, which has helped revive investor interest in the stock for its growth prospects. “They could easily have become more of an income play, but [the company] recognized there was a transformational cloud opportunity,” says Wedbush’s Ives.
Like other legacy tech stocks, Cisco has seen its yield drop as well. It was recently at 2.4%, down from 3.5% about two years ago.
The stock trades at about 18.7 times its fiscal 2019 profit estimate of $3.08 a share, according to FactSet. By comparison, the Technology Select Sector SPDR exchange-traded fund (XLK) trades at 21.3 times its 2019 earnings estimate, according to FactSet.
Katz calls Cisco’s valuation “OK,” adding, “they have good growth prospects.”
The company, whose products include switches and routers and other networking tools, is expected to earn $3.41 a share in its fiscal year ending in 2020, an 11% jump. The company’s board in February declared a 6% dividend increase to 35 cents a share from 33 cents, and it has boosted the payout every year since 2012.
Among the other tech dividend payers listed here, IBM (IBM) sports the highest yield at 4.3%—a reflection of how the stock has struggled in recent years. It has a five-year return of about minus 1.4%.
The company has made a big bet on cloud computing, which accounts for roughly 25% of its revenue, up from 4% in 2013. Toward that end, IBM recently completed its acquisition of Red Hat in a $34 billion deal.
Katz says he has a small position in IBM, whose dividend is more than 100 years old. It’s one of the cheapest legacy tech stocks, trading at less than 11 times its 2019 profit estimate.
“It seems like they are moving in the right direction,” says Katz. But he adds that “there’s definitely more business uncertainty with IBM than with Cisco or Microsoft.”
Despite all of the cash these tech behemoths have on their balance sheets, there isn’t a lot of buzz about special dividends, and there’s little precedent for such payouts. Microsoft, for instance, issued a special dividend of $3 a share in 2004, but it hasn’t done one since.
For now, Microsoft and other legacy tech companies seem content to pay their quarterly dividends and increase them regularly.
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