The Maturation Of Large Cap Tech Stocks

Technology companies have largely been avoided by many dividend investors, and often for good reason.

-Tech stocks have often lacked durable competitive advantages due to the swift nature of change in the tech industry.

-It’s important to have a solid understanding of the company that one invests in, and for tech companies that is often a problem for investors.

-Tech companies have had notoriously low dividend yields. Part of this is justifiable; aspects of the tech world are cyclical, and cyclical companies that desire to increase dividends each year (even if EPS decreases some years), need to keep payout ratios manageable, and they often supplement their dividends with larger share repurchases. The other part has to do with a culture that doesn’t focus on creating shareholder value.

Even as an electronics engineer by profession, I’ve always kept tech as only a small place in my portfolio, and plan to continue that trend. I’ve only invested in tech companies whose products I use regularly, and whose competitors I am familiar with as well (so that I can experience their moat first hand).

Over the last few years, however, I believe some of the large technology companies have matured to become more mainstream for dividend or value portfolios. Some of this has to do with size; companies like Microsoft (MSFT), IBM, Intel (INTC), Texas Instruments (TXN), and others, have become rather large organizations. Another part has to do with increased dividend yields. Years of low yields and fast dividend growth that outpaced EPS growth has eventually resulted in reasonable payout ratios and dividend yields for some of these businesses. Other companies, like Cisco (CSCO) and Oracle (ORCL), have recently begun paying low dividend yields as opposed to no dividends at all. The third part has to do with diversification; rather than relying on a single product, many of these large tech companies have a large collection of products and services that they make money from, and they’re large enough to buy out some competitors and change their product lineup with changing technology. This results in a moat of intellectual talent, patents, and significant amounts of capital.

A reasonable comparison for large and mature tech companies is to view them in a similar light as large diversified health care companies. Some of the products that these businesses make, such as medical devices or pharmaceuticals, are enormously complex, and yet they can be found in most dividend portfolios, including mine. But even though many investors may not understand the specifics of the products, they clearly understand the purpose of those products, and perhaps more importantly, understand the large patent shields, the significant benefits of scale and capital, the organized collection of scientific talent, and the diversification of their products. This means that even if one or a few of these highly complex products fails, there are multiple backups, and an investor that lacks medical and chemical knowledge can review the diversity of the products to get a decent understanding of the financial risk involved.

I believe that a select few tech companies have reached a similar position. Although there are some companies, like Apple (AAPL) or Google (GOOG) that are large but do not pay dividends or buy back shares, there are several others that do offer substantial and growing dividend yields, and a good potential overall value.

Personally, I’ve often had a tech company in my portfolio at a given time, but I prefer to keep tech to a reasonably small allocation of a total portfolio. I’d be cautious regarding making any huge bet on a single tech stock, and make sure that I do have a solid understanding of the business. For both tech and health care, I avoid making individual large investments. For health care, this has meant investing in numerous businesses, and for tech, this has meant keeping my allocation to that sector relatively small. I held Adobe (ADBE) stock years ago before I began focusing on dividends, and I held Texas Instruments up until I decided that I had a bit too much of a conflict of interest at work and should probably not hold the stock at this time. Currently, I now hold Microsoft as my tech stock of choice, while Intel and IBM have remained on my watch list for some time, and Texas Instruments remains on my watchlist for a time when I feel there is less of a conflict.

Here are a number of tech stocks that I feel may have matured into companies that could hold some interest of dividend investors if kept to a reasonable allocation amount.

International Business Machines (IBM)

With a huge $228 billion market cap, over 15 years of consecutive dividend increases, and 100 years of operating existence, IBM may have something to offer. The company now focuses primarily on software and services, as well as integrated solutions for enterprises. IBM has also made over 100 acquisitions over the last 10 years. This model of middleware and operating system software, services, enterprise solutions, and acquisitions, gives the company a lot of flexibility as technology changes. The key downside for dividend investors, unfortunately, is the dividend itself, since the company only offers a 1.55% dividend yield, and fills the rest with share repurchases instead.

Microsoft (MSFT)

Microsoft lands with the second highest market cap on this list, only a bit behind IBM. The dividend yield is currently over 3%, and the company has provided generous dividend increases. Most of the cash flow for the company is generated by Windows, Office, and the server and tools segment which serves businesses and prepares cloud services. Microsoft also offers the Xbox and Xbox live, which along with their Kinect and external services like Netflix, has turned into more of a total media device than a gaming console. The company has presence in online search, and now owns Skype. They’ve had consistent trouble getting a foothold into the world of mobile computing, however.

Intel (INTC)

With a $130 billion market cap and a 3+% yield, Intel is worth being looked at by investors. Unlike some of these other large cap tech companies, Intel is in a fiercely competitive environment; the company is only as good as its latest set of processors. Every two years, the company needs to have the best product on the market. This makes Intel less diverse, and harder to predict than the previous two companies listed, in my view. If I recall correctly, I used Intel as a potentially negative example in an “invest in what you understand” article a while back. The upside for Intel (besides the pristine balance sheet, fair dividend yield, and low valuation), is that its scale gives it an unmatched budget for research and development. Even when other companies come close to providing products as good as Intel, like AMD did a few years ago, they can’t sustain the race for long. If a competitor comes close, Intel still has billions available for the next wave of innovation, while its competitor is likely “out of ammo” after such a big push to catch up. Like Microsoft, Intel has had some trouble in the mobile arena, as ARM architecture has proven to be a more energy efficient solution so far. Intel is in my view the most difficult to predict out of the top four companies listed here.

Texas Instruments (TXN)

Texas Instruments, with a $35 billion market cap, is fairly large. The dividend is now comfortably over 2%, which is low by dividend investor standards but a high for the company after it began significantly growing its dividend in recent years to more reasonable levels. Although all of these companies operate against substantial competitors, TXN doesn’t have quite the breakneck competition as Intel does. Unlike Intel, which must constantly output cutting edge processors every cycle, Texas Instruments has a large analog segment, microcontrollers, and calculators that all have rather long product lifecycles. These products provide substantial profit margins, and add a buffer and some diversity for some of Texas Instrument’s more cutting-edge products. Still, each year TXN does have to continually re-asses its position, make sure its products are targeting the right technology, and win contracts against competitors.

Honorable Mentions

In addition to the above listed, there are several other choices.

Oracle (ORCL) has a market cap larger than Intel, but has a larger presence in software than hardware. It’s a competitor to IBM, has dominance in the database market, and offers integrated and consolidated IT solutions. The company now pays a dividend, but its yield is under 1%.

Cisco (CSCO) also has a large market cap, and has also recently started a set of dividend payments. The yield is better than Oracle, but lower than IBM, at 1.26%. As one of the backbones of the internet, Cisco provides networking devices and other electronics. The company is likely not a suitable candidate for dividend portfolios, but may make for a reasonable value pick, and over time, Cisco and Oracle may offer yields over 2% or 3% if they follow the trend of some of the other large companies on this list. Instead of paying meaningful dividends, the company currently buys back significant amounts of shares.

Analog Devices (ADI), a $10 billion company, focuses on analog electronics. Analog products are difficult to produce, offer high profit margins, and have very long product cycles (on the order of years or in some cases decades). The dividend yield is 2.79%, and has a decent stretch of consecutive annual dividend growth.

Maxim (MXIM) offers the highest dividend yield on this list, at 3.43%, along with fair dividend growth. The company focuses on high performance analog. A few years ago, the company was temporarily delisted from the Nasdaq due to issues relating to options.

Linear Technology (LLTC) is a $7 billion company that focuses on very high-margin high performance analog devices, and avoids chasing high-volume, lower-margin industries. The dividend yield is over 3%, and the dividend has consistently grown each year for quite a while now.

Conclusion

Overall, I think adding a bit of tech to a portfolio is a wise move, but unless I was willing to follow the company rather closely and often, I’d stick to some of the largest names on this list, rather than venture into other large cap (but significantly smaller), dividend-paying companies like Analog Devices, Maxim, and Linear Technology. I’m interested in readers thoughts- do tech companies have a place in your dividend portfolio, and how do you relate some of these diversified large cap tech companies to large cap health care companies?

Disclosure: At the time of this writing, I own shares of MSFT, and no other companies mentioned. You can see my portfolio here.