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Bearish folks think tech companies, by paying dividends, are signalling that they have no “better” use for the cash. However, in some cases, companies that kept all their cash often misspent it on unprofitable initiatives or ill-conceived acquisitions. A polar bear growls at the St. Felicien Wildlife Zoo in St. Felicien, March 5, 2009 (MATHIEU BELANGER/REUTERS)
Bearish folks think tech companies, by paying dividends, are signalling that they have no “better” use for the cash. However, in some cases, companies that kept all their cash often misspent it on unprofitable initiatives or ill-conceived acquisitions. A polar bear growls at the St. Felicien Wildlife Zoo in St. Felicien, March 5, 2009 (MATHIEU BELANGER/REUTERS)

Don’t be a bear on U.S. tech dividends Add to ...

Recently, Bloomberg ran a story suggesting that the decision by certain tech companies to pay higher cash dividends in 2012 was a show of weakness and in fact a heads-up on a coming bear market in their stock prices.

This observation was based on:

1.) Conventional thinking that technology companies are investable only when they are in their fast growth stage and not as mature businesses.

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2.) Very short-term observations about a handful of tech companies that had recently raised their dividends, compared with those tech companies that did not increase their payouts.

We look a bit askance at this. First, on the basis of a short reporting period, the article purports to make a much more general point that paying dividends by tech companies is a sign of lost mojo, of – dare we say it – maturity, and all the unexciting things that go along with that status.

There are a few problems with this thesis. First of all, Apple, the epitome of runaway tech success and rampant market outperformance, now pays a dividend, which it initiated this March. Cisco Systems, another tech giant, had been in the doldrums until it raised its dividends this August.

Some may say that these are the exceptions that prove the rule. But even if the correlation of tech companies’ short-term market performance and dividends is less than clear, the article does raise the question of the implications of tech companies paying a dividend.

Perhaps the concept is outdated that tech companies, by paying dividends, are signalling that they have no “better” use for the cash. We believe this for a few reasons.

In some cases, companies that kept all their cash often misspent it on unprofitable initiatives or ill-conceived acquisitions. This kind of thinking reigned supreme when these companies were trading at astronomical price-to-earnings ratios. Paying out cash would have shone a harsh and unflattering light on those multiples.

Today, taking shareholder needs into account is indeed a sign of maturity, and this should be considered a very favourable development.

Another factor is that many tech companies have done so well that they can have their cake and eat it – retain as much cash as they need for growth, R&D, marketing, product development, etc., while also respecting their shareholders. Yes, they are more mature, because they have proven to be wildly successful. And yes, their P/E multiples reflect that maturity, so that paying a dividend will no longer be seen as a deflating, disillusioning step.

Then there is the recent market environment to consider. In the past two years, the “risk off” trade has dominated market psychology more often than not. In such an environment, shareholders have flocked to the most defensive sectors, industries and holdings. High-dividend stocks have vastly outpaced low– and no-dividend-paying stocks. The differential in returns has been so pronounced that more and more CEOs and boards are getting the message.

Although tech companies did not fit this defensive profile, those that paid higher dividends did tend to have more stability than their non-dividend-paying peers that had comparable business profiles.

As dividends have again become recognized as an important aspect of stock’s total return, technology boards that have taken note of this have helped improve their companies’ returns for investors.

Drug companies provide an example of this dynamic, and we expect it to provide a road map for technology companies. A few years back, when growth prospects for some mega-cap drug companies declined, company boards made their dividends a priority and an important aspect of their total return to shareholders. Although the initial reaction was negative, the dividend payments have evolved into a big plus. In fact, this high yield was a major reason this group fared very well in the past 18 months.

All things being equal, we like dividends a lot (especially in this exceptionally low-interest-rate environment). But when we look at companies to invest in, it is merely one of the many considerations. However, in those cases where we like a business and are able to buy the stock at a favourable price, we look at healthy and growing dividends as the icing on the cake.

Here are a handful of healthy-dividend-paying technology stocks that we believe will be good six-month to 12-month investments that will reward shareholders while they wait:

  • Applied Materials
  • Cisco Systems
  • Dell
  • Intel
  • Microsoft

Any help to the U.S. economy as of result of the Fed’s announcement of QE3 last Thursday, as well as Europe’s stabilization and China’s move toward reigniting economic growth, would be a windfall for each of these business and for their stocks.

Editor’s note: David Katz is the president and chief investment officer of Matrix Asset Advisors, which he co-founded in 1986.Matrix clients, his mutual fund, Katz and his family (through his ownership in the mutual fund) own and continue to buy CSCO, DELL and MSFT. Matrix clients who are focused on our dividend strategies own INTC (Katz does not INTC) and Matrix clients and Katz do not own AMAT. There are no other conflicts of interest.

 
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