An increasing number of tech companies have begun to pay dividends to shareholders, making the sector a good source of income.
Received investment wisdom would view technology stocks firmly as a growth-only proposition. However, for those seeking income, this could be a costly mistake. Despite volatility in the market and worries over new regulation, an increasing number of tech companies have begun to pay dividends to shareholders, and we view the sector as a significant future source of income generation.
Cutting edge firms, old fashioned views
Traditionally, tech companies have invested a high proportion of earnings back into the business, which has generated a strong level of growth – almost 80 per cent compared to 35 per cent for the wider index in Sterling terms. Companies in the sector that did not follow this model and paid out profits as dividends were frequently perceived as legacy tech companies, already past their prime.
Worried about being viewed as ex-growth, even companies that have had very high profit levels, such as the FAANG companies, have tended to maintain strong net cash positions rather than paying out profits to shareholders.
Viewing companies that pay dividends as ex-growth is however, a misconception. Increasingly, the tech sector is offering opportunities for income alongside high growth across a range of cutting-edge tech investments. Few people think of firms such as Nvidia, Tencent and Microsoft as legacy tech, and each of these companies has demonstrated that high growth can be achieved while paying dividends to investors. In fact, while each of these firms has increased dividends in recent months, Nvidia and Tencent have paid out less than 12 per cent of earnings to shareholders, so there is still a large amount of capital left to reinvest.
Investing in tech pays dividends
Despite the prevailing wisdom, we are seeing that shareholders have started to recognise the benefits of investing in tech companies that provide a regular income. Some have begun to see the act of paying dividends as an indication of a company’s disciplined approach to capital allocation, rather than demonstrating a lack of commitment to growth and innovation. Moreover, paying dividends tends to provide better shareholder returns over the long term than companies which purely reinvest in the hope of high growth.
Outside of shifting perceptions, Donald Trump’s changes to US corporation tax have made the repatriation of off-shore funds more attractive for US tech companies. Cash held in overseas bank accounts generates little to no return, so tax cuts will encourage companies to repatriate funds, both to invest in growth and pay out dividends to shareholders. The US is one of the most significant regions for the technology sector, and many big-name brands, including Apple, have been considering using this money to increase shareholder pay outs once repatriated.
While small cap tech companies will likely maintain the model of investing most of their profits into the business due to limited capital, more established companies in the sector are well positioned to maintain growth while increasing dividends.
The risks of smalls caps
Smaller cap companies are often considered to be high growth, high risk investments. While they are able to pursue new technologies, the reality is that many firms lack the financial clout to deal with the setbacks that frequently arise in emerging tech. For those looking to have access to interesting investments in cutting-edge technology without such high levels of associated risk, the established giants can offer this, while also providing more reliable returns and dividend payments. Firms like Microsoft allow investors access to AI and cloud technology, providing them with the opportunity to benefit from the growth that comes from continuing innovation, as well as regular and reliable dividends.
What next for the world of tech?
With infrastructural changes on the horizon including the roll out of 5G and consumers’ ever-increasing demands for memory in high performance computing, the tech sector presents a number of exciting opportunities to achieve growth as well as income. While most traditional income strategies will have ignored the tech sector, we feel that this is a natural and important area to include in our portfolio. We hold stocks in Microsoft, Apple and Samsung among others, and it is in these historically growth orientated stocks that we see some of the best dividend growth prospects.
As large tech firms continue to push forward the boundaries of innovation by developing pioneering technologies, we expect to see ever more interesting opportunities for the savvy income investor in this sector.
Mark Whitehead is a portfolio manager at Securities Trust of Scotland