WHAT ARE WE LOOKING FOR?
North American information-technology stocks offering the most attractive dividend profiles.
DIVIDENDS ARE IN, CASH FLOW IS OUT
In a research report Tuesday, TD Newcrest technology analyst Scott Penner noted that free cash flow is, in general, a good valuation tool to use for tech-sector stocks. However, the recent flurry of takeover activity in the sector (most notably Hewlett-Packard Co.'s winning bid for 3Par Inc., at more than triple the pre-bidding-war trading price), combined with the sluggish economy, has him worried that it might not be the best tool in the toolbox right now.
"When organic growth is more challenging and acquisition premiums are high … the presumption could be that capital deployment will become undisciplined," Mr. Penner wrote. In other words, companies with loads of free cash flow can't be trusted not to waste it when an M&A frenzy takes hold of the sector's senses.
"In this scenario, he said, "high FCF yields may be looked at with caution," while "dividend yield would take on higher importance."
To this end, Mr. Penner looked at the top dividend-payers among technology stocks traded on Canadian and U.S. markets. Not only did he look at yield, but he also considered dividend consistency and growth (screening out stocks that had cut their dividend in the past three years), as well as financial growth (he only considered companies whose revenue and free cash flow had grown over the past three years).
Ranked by dividend yield, three of the top six stocks passing the screen are Canadian - MKS Inc., Calian Technologies Ltd. and Computer Modelling Group Ltd. Eleven of the top 20 are software/services companies, while six are semiconductor makers and three are hardware makers.
Mr. Penner drew particular attention to the small-capitalization names on the list - which includes the three top Canadian names. He argued that there is a buying opportunity in these small-caps, since small-cap tech stocks in general have underperformed large-cap techs in recent months.
He noted that two of the small-caps that passed the screen - MKS and Enghouse Systems Ltd., another Canadian name - also have "outsized" free-cash-flow yields of 13 per cent to 14 per cent.