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The tech sector's favourite new gadget? Dividends Add to ...

The tech sector has grown up. So maybe it’s time to have a grown-up conversation about what that means for investors.

Microsoft Corp.’s decision this week to raise its dividend by 15 per cent made it the latest in a string of large-cap technology companies, including Apple Inc., Cisco Systems Inc. and Dell Inc., to either introduce or substantially increase dividends in recent months. The recent announcements are all part of a broader dividend bonanza in the sector: Payouts rose 26 per cent last year, and Moody’s estimates they will be up another 14 per cent in 2012.

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Tech companies used to be famous for burning through money, using it as fuel to power spectacular profit growth (or, at least, that was the marketing pitch and investors’ hope). Now, they make so much money they can’t spend it fast enough. The words “sitting on a pile of cash” can be applied to a broad swath of the sector.

Hence the dividend windfall for investors. The S&P 500 information technology now pays a collective dividend yield of 1.7 per cent.

A decade ago, the sector’s yield was about 0.3 per cent. Even five years ago, it was under 0.6 per cent. In other words, an afterthought for investors, who saw techs (for good reason) as a cyclical growth play.

Now, the sector’s yield rivals that of the broader market. It hasn’t quite caught up with the 2-per-cent yield for the overall S&P 500, but it’s in the ballpark and is nipping at the heels of the traditionally dividend-rich financial sector, which is yielding 1.8 per cent.

And techs could easily afford to close the dividend gap further. The group’s overall payout ratio – its dividends as a percentage of total discretionary cash flow – was just 21 per cent last year, less than half of the 43 per cent rate for non-tech stocks. Six of the 10 most cash-rich balance sheets in the U.S. market belong to technology companies. Moody’s said the tech sector has enough cash on hand to cover a whopping 941 per cent of its 2011 dividend obligations – more than triple the typical levels of non-tech sectors – and is by far the best positioned industry to keep up its dividend payments in the event of an economic slowdown.

This is great, right? Here we have a sector that is known for its growth potential, that has long ridden the crest of the economic cycle, that typically outperforms the rest of the market on the way up. And here we have an economic cycle that’s bound to (eventually) accelerate, and we can get in here before the rocket takes off. And it’s doling out bigger and bigger heaps of cash to pay me while I wait? Where do I sign up?

But there’s a problem. As tech stocks have become bigger dividend payers, their profile as a cyclical growth sector has evaporated along the way.

A decade ago, the S&P 500 information technology sector had a beta of a whopping 1.6, making it far and away the most volatile sector in the market. That beta implies that every time the broader market moved 100 points, the info tech sub-index was apt to move 160. Not so good in a bear market, but a huge upside for investors in a bull market.

Now? The sector has a beta of 1.1 based on the past two years. That’s still more volatile than the broader market (which, by definition, has a beta of 1.0), but not wildly so. Tech’s beta ranks in the middle of the pack among the 10 major industry sectors in the S&P 500.

Technology stocks have gone from being the roller-coaster thrill ride to a stable cash generator with the safest dividend profile in the market. How did this happen?

In short, the main players in the sector have matured. Their biggest growth years are behind them, and their businesses have, generally, become more stable, less risky, more predictable. Their success in generating cash has given them an ample cushion to absorb business and economic shocks.

But sustainable growth will return to the economy and the markets, and when it does, growth stocks will be in vogue again. Investors’ instinct may be to latch onto the technology sector as one of the beneficiaries of this next growth wave. (Indeed, it may already be happening, reflected in tech’s recent outperformance in the market’s summer rally.)

That instinct would be wrong. While there will always be growth plays within the technology sector (as with many other sectors), the key players in the tech sector simply aren’t those kinds of companies any more. They look like a safe bet, even a good bet. But you think they can be a big-growth bet at the same time?

Grow up.

 

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