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Tech Giants Find Dividends Worth The Price

Technology stocks aren’t known as big dividend payers, but as more companies reach maturity, they’re finding dividends to be a viable option.

Apple iPad 2
Source: Apple
Apple iPad 2

And with the recent stock market volatility, investors looking to do a little spring cleaning of their portfolios may want to consider dividend-paying tech stocks.

When a stock pays quarterly dividends, it’s a sign that a company has reached a stage where it doesn’t expect robust organic growth. But tech stocks are generally regarded as rapid-growth companies, which is why they’ve historically shied away from paying dividends. It’s why a high flyer like Apple doesn’t pay a dividend. (It did, however, dish out a one-time dividend in 2004, and previously paid regular dividends from 1987-1995.)

“When companies are in growth mode, they are more about reinvesting than paying out to shareholders,” says Frederick Moran, an analyst at The Benchmark Company. “The shareholders that own tech stocks are not there for safety and security—they’re there for growth first and foremost.”

But as the profile of established large-cap tech stocks has changed, so have the demands of investors.

“A lot of these leading technology stocks often have no debt and cash-rich balance sheets,” Moran says. “That cash serves relatively no purchase from an operational standpoint and can actually be a negative on a stock’s trading multiple and its valuation because it earns much less income than does the company itself. Shareholders are not seeking an investment in cash, they’re seeking an investment in a company.”

Pros and Cons

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Measuring the benefits of dividend payments is a balancing act. For tech companies, it’s a matter of whether the valuation support that dividends provide justifies the implicit admission that their organic growth opportunities are limited.

Last fall, Cisco Systems announced it will begin paying a dividend to shareholders for the first time during its fiscal year ending July 30 — a sign that some established large-cap tech stocks are realizing the value of dividends.

“It is something that has spread among the largest cap technology shares, but those are the stocks where the valuations have come down, so they’re already appealing to value investors,” says Kevin Buttigieg, senior analyst at Collins Stewart. “For a lot of the rest of the universe, especially mid-cap and small-cap stocks, that trend is not changing at all and I don’t expect it to.”

For investors, it’s a matter of figuring out how much protection they need from market volatility versus stocks that offer significant growth opportunities.

“People like dividend yields because it does present some sort of downside protection,” says Brian Marshall, senior equity analyst at Gleacher & Co. “Stocks are telling us the direction of the market going forward, and clearly it’s not up and to the right unequivocally anymore.”

Here's a look at dividends in key sub sectors.

Hardware/Semiconductors

Computer hardware and semiconductor companies are among the most mature within the tech sector. And no company symbolizes market maturity more than IBM , which is why it’s no surprise that it’s one of the better dividend payers in the hardware industry with an annual yield of 1.7 percent (the S&P 500 dividend yield is about 1.8 percent).

Intel, the top PC semiconductor manufacturer, is also generous with its shareholders, with a 3.5 percent-dividend yield. And Hewlett-Packard recently announced it would raise its quarterly dividend 50 percent to 12 cents per share, or a yield of 1.1 percent based on its current price, beginning with its May dividend payment.

But dividend payouts should never be the sole reason to invest in a company. Marshall notes that like many dividend-paying companies, IBM’s growth prospects are limited.

“The case against IBM is limited revenue growth,” Marshall says. “That means manufactured earnings growth through trends more toward high-margin revenue sources, like services and software as opposed to commodity hardware, as well as [operating expense] reduction and share buybacks.”

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Software

“Software seems like it should be a natural place for companies to be dividend payers, because they typically generate a significant amount of cash, cash flow streams are pretty steady, and the investment requirements are pretty low—you’re not using cash for manufacturing facilities, for example,” says Buttigieg.

For years,Microsoft was known for sitting on its ever-growing hoard of cash rather rewarding shareholders. But the company began paying a dividend in 2003, which now yields a healthy 2.55 percent. Business software maker Oracle began its dividend program in 2009, but its yield is a relatively tepid 0.65 percent.

Buttigieg points out that both companies face challenging market conditions.

“The concern with Microsoft is that the PC market is being cannibalized by tablets and smartphones, where Microsoft has a much less prominent position,” he says. “In the case of Oracle, they’re subject to risks in terms of the industry moving to software as a service, and Oracle sells a lot of their software in an on-premises model.”

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Internet

With the possible exception of mobile communication, no other group within technology symbolizes rapid growth more than the Internet sector. That’s why even established players likeGoogleand Amazon don’t pay dividends.

An exception to the rule is online travel service Expedia, which began paying dividends a year ago. Its annual yield is 1.3 percent.

“The case in favor of Expedia is given their relatively early adoption of a dividend, they’ve shown great dedication to rewarding shareholders,” Moran says. “A shareholder should therefore be comfortable their interests are being put first. From an investment thesis perspective, the question is how much can Expedia grow and how much can its stock price appreciate based on its current fundamentals.”

In contrast, Priceline.com , another established online travel service, does not offer dividend payments.

“Priceline is not going down the dividend route because it doesn’t see any purpose to it right now,” Moran says. “But if it were to offer it, and financially it could easily offer it, it would only help the stock’s attractiveness to investors.”