Isn't it time high-tech grows up? The tech sector is the biggest money earner and pays out more in dividends than any other industry group, according to S&P Capital IQ data. But in the present earnings season, it's the sector's inconsistency that has been on full display.
Apple managed to beat Wall Street's expectations this week, but earnings were down $2 billion and iPad sales dropped. Google and Microsoft have both reported disappointing results.
But even as the sector is reporting bottom-line busts, it's generating cash at record levels and paying out dividends at an ever-faster rate. That sounds like the model of a mature business, but finding a tech company that steadily grows earnings and predictably increases dividends is still a tough proposition.
"The tech sector will never mature because it is a new-product sector, and the stocks are not going to move with the market and they are not going to move on dividends. It's still all about innovation," says Susan Fulton, owner of FBB Capital Partners. "They have to keep reinventing themselves."
But as the likes of Microsoft and Intel become known as reliable dividend payers, the sector is suffering from a blurred image among investors, analysts say. Executives who once shunned dividends because such payouts would signal that their companies were no longer growing have changed their opinions partly due to shareholder pressure. Still, it's not clear that more generous dividend payments have helped share prices.
The tech sector has boosted its dividend yield to 1.9 percent from 1.2 percent over the past two years, nearly reaching the S&P 500's average yield of just over 2 percent, which has remained relatively unchanged, says Scott Kessler, head of tech equity research at S&P Capital IQ. About half of all companies in the S&P making their first dividend payout were in the tech sector during that period.
"The yields have increased substantially over the past couple of years," Kessler says. "But the tech sector still sells at a discount to the overall market. The dividends have really not made much of a difference."
Can you expect dividend increases if you own tech stocks? In many cases, yes, Kessler says. "They have the wherewithal to pay more. They have very profitable business models, very strong balance sheets. They are really overcapitalized," he says.
Basically, that means they have too much money for their own good. That cash has to be reinvested in growth or paid out in dividends. Another alternatives, such as letting the cash sit in foreign bank accounts that go untaxed by the United States, for example, could cause major controversy, as it did for Apple this year.
For tech companies, the innovators' dilemma is compounded by shareholder demands. "People want innovation, and yet they criticize every effort at investing in new products and suggest the companies are not doing enough for shareholders," Kessler says.
That was apparent in a number of the latest quarter's results for big tech companies. A few highlights:
• Google, always a big investor in new products, disappointed with weaker earnings as its mobile investments led to an unusual profit decline despite higher revenue. Its stock fell 1.5 percent on the report.
• Microsoft's shares dropped 15 percent in the week after it took a charge of nearly $1 billion related to its struggling tablet computer. It pays a dividend of 2.6 percent.
• Apple's earnings dropped $2 billion from a year ago, the result of failing to meet new competition with new products. Samsung, its biggest competitor, has been growing more quickly globally. Still, Apple's stock was sharply higher after results this week topped expectations. Earlier this year, the company announced a $100 billion plan to pay for stock dividends and share buybacks.
• Yahoo reported higher earnings, but its core advertising and search revenue fell sharply. The company has made a string of acquisitions to boost growth. It pays no dividend now, but Yahoo has been the target of activist investors who dogged the company after it refused a premium buyout offer from Microsoft five years ago. It bought back $1.2 billion in shares from Daniel Loeb, another activist investor, earlier this week, leading to a 5 percent decline in its stock.
• Intel's revenue and profit declined sharply on falling PC sales. The company has been investing in mobile phone and network security, but its stock has been stagnant for a decade. Intel has long embraced dividends, though, and its dividend yield is currently 3.9 percent.
• Facebook turned in the biggest surprise with a stunning 53 percent surge in earnings for the quarter, partly because it managed to turn mobile advertising into a big source of revenue. Shares leaped 17 percent after the report, demonstrating how quickly the fortunes of tech stocks can change. A year ago, Facebook's failure to anticipate the rapid growth of mobile spoiled its initial public offering, a critical misstep that caused its shares to plunge. With this week's gain, it's within $8 of its $38 IPO price.
Broadly, the sector's disappointing results reflect intense competitive pressures. But the high cash levels many firms hold are creating pressure to pay out dividends anyway. One of the biggest tech names, Dell Computer, frustrated over its lagging share price, has been attempting to use that cash to take the company private.
Shareholder activists have been pushing the companies, including Dell, to share their riches. Carl Icahn has been actively trolling in high-tech, and not just the sector's aging giants, like Dell. He is also a major investor in high-jumper Netflix. Even Apple, as big as it is, was not too big to discourage corporate raiding. David Einhorn took a large stake in the company and pushed for action to boost its share price.
Fulton says the best strategy for investors looking for more stable returns in the tech sector is to avoid companies like Apple, whose growth prospects depend on short product cycles. She says companies like Qualcomm and Xilinx generate much of their revenue from licensing, not products, so they have steadier income streams. Both pay dividends as well. She says if investors decide to buy tech stocks, they should be prepared to ride out volatile product cycles.
"I would not buy a tech stock that does not pay a dividend," Fulton says. Those payouts reflect a commitment to steady, reliable earnings. Tech mutual funds with a track record of making solid picks may be a smoother way for investors to dabble in the sector, Kessler says.
Size matters, too. For bigger companies like Apple, recurring revenue that really affects the bottom line is hard to find. IBM has done a much better job of transforming itself into a tech company with recurring revenue business, Fulton adds.
"A lot of tech companies are becoming more mature," Kessler says. "But growth is getting harder to come by. Investments carry a lot of risk. That's the impetus for the dividend increases. The market is starting to respond favorably. Investors, especially baby boomers who want income, are looking for that, and the companies are responding."