Information technology is one sector that’s not represented in our Portfolio. Although this sector has made important contributions to the US economy over the past several decades, technology companies are notoriously stingy when it comes to paying dividends.
This stinginess makes sense: With shorter product cycles, technology companies must plow a big chunk of their cash flow into developing new innovations that will drive future growth and offset declining revenue when their current lineup becomes obsolete or falls out of favor.
During the 1990s, many tech investors mocked dividend investing as the “old normal,” an inferior strategy doomed to perpetual underperformance relative to the high-flying Nasdaq. In fact, the consensus view held that income-seeking investors would be better off dumping their dividend payers, buying “growth” stocks and selling some of their ever-appreciating holdings when they needed cash.
By the early 2000s, this strategy saddled its adherents with huge losses. Now, after more than a decade of solid returns for dividend-paying equities, many popular tech stocks have initiated dividends of their own to cash in on investor demand.
A reliable dividend has boosted the appeal of Intel Corp (NSDQ: INTC), Microsoft Corp (NSDQ: MSFT) and other tech giants that dominate their fields and generate huge amounts of cash flow but no longer deliver explosive revenue and earnings growth.
Nevertheless, investors shouldn’t assume that these companies have beaten the business cycle. Apple (NSDQ: AAPL) may be riding high today, but don’t forget the hard times that the company experienced in the early 1990s. And remember that someone can always build a better mousetrap.
Tech companies have sought to offset these inherent risks by limiting their debt loads and keeping their payout ratios moderate. But even the industry’s largest players lack the highly visible stream of recurring cash flow that enables a utility or pipeline company to disburse such generous dividends to its shareholders.
Tech and Dividends
Investors should be highly skeptical of any tech company that pretends the product cycle doesn’t exist. However, owning a dividend-paying tech stock provides valuable balance to our Lifelong Income Portfolio; these securities tend to rally when investors become excited about economic growth and less enamored with safety and dividends.
Exposure to this sector can help to offset temporary selloffs that occur in master limited partnerships, real estate investment trusts and utility and telecom stocks when the market starts to worry about rising interest rates.
These stocks will also appreciate in value as their dividends grow over time. Excluding companies at risk of cutting their dividends leaves you with an investable universe that usually yields 2.5 percent to 3 percent. We focused on names that have managed to grow their payouts steadily to maximize our total return.