Nifty-Fifty. Dot-Com. Social Media. Unicorns. Typically technology stocks have been classified with a spiffy name so investor relations and analysts can tell their high flying growth story easier. However the tech sector, which represents nearly 20% of the S&P 500, is no longer littered with companies trading at ridiculously high valuations based on unachievable earnings expectations like the late 90’s. The survivors of the dot-com bubble are mature, value stocks, with management teams focused on returning cash to shareholders. The latest name for the group should be “income plays.”
Tech companies like Apple (AAPL), Microsoft (MSFT) and Cisco (CSCO), are drowning in cash (30% of Cisco’s market cap value is in cash). Their business models are not capital intensive. Their balance sheets are also not saturated with debt. Pension obligations and the burdens of the “old economy” are non-existent. Only so much can be reinvested into Research and Development. What to do with all of this cash?
Most Tech companies hold a large portion of their cash overseas to avoid paying US corporate taxes. However, if President Trump and the Republican controlled Congress follow through on their agenda of tax reform, they could allow for a tax repatriation holiday at a much lower rate. This would give stocks in the technology sector a huge lift.
For many years, a tech company buying back stock merely offset option dilution, leaving net outstanding shares about even. Now, they are actually reducing shares outstanding. During the first quarter of 2016, technology companies spent the most in terms of dollars, $30 billion, of the entire $125.1 billion of shares repurchased, by the all companies in S&P 500. *
The Technology sector has the fastest dividend growth rate of any sector in the S&P 500 over the past seven years, growing 20% annually. ** Paying out a dividend is typically a capital allocation decision for a mature company whose best growth days are behind it, such as utility, telecom, and industrial stocks. Although the absolute yield is one of the smallest compared to other sectors in the S&P 500, (Tech yields 1.5% vs 2.1% for the index), companies in the tech sector are only paying 20% of their earnings in the form of a dividend.*** This implies there is wiggle room for more.
The US economy is heating up. Inflationary pressures appear to be percolating. If a major fiscal policy is enacted, at a time when the unemployment rate is at 4.9%, and wage growth at 2.5%+, along with crude oil prices rising, the Fed could be forced to raise rates at a faster pace than the market expects. Bond-like surrogates, such as Utility, REITs, and Telecom stocks will under perform. The focus for income investors will shift from absolute yield, to growing income to keep up with, and or surpass, inflationary pressures. This should favor large cap technology stocks committed to returning cash to shareholders.
When looking for income in this low yield world, you should not focus entirely on the stated yield, but also the commitment management has made to the dividend, the balance sheet to support the dividend, and the payout ratio to provide more room to grow the dividend. In an environment where rates can rise fast, stated yield may not be as important as the growth of income. The high-flying tech stocks of yesteryear are the income darlings of today.
Note: John J. Petrides, MBA, is a Managing Director and Portfolio Manager at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit.
CNBC has named Point View number 5 on its list of the top 100 fee-only wealth managers in America! See http://www.cnbc.com/2015/06/03/cnbc-charts-the-top-100-firms.html.
Point View Wealth Management, Inc. works with families in Summit and beyond, providing customized portfolio management services and comprehensive financial planning, to develop and achieve their financial goals. We are independent and fee only. How can we help you? Contact John Petrides (firstname.lastname@example.org), David Dietze (email@example.com), or Claire Toth (firstname.lastname@example.org), or call (908) 598-1717 to learn more.
*Factset, Buyback Quarterly, September 20, 2016
***Factset, Dividend Quarterly, June, 22, 2016