Dividend Increases: How Do They Impact Technology Companies?

By Bill Edson - September 20, 2012 | Tickers: AAPL, GOOG, MSFT | 0 Comments

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Some of the tech giants in the United States have increased their dividends by a significant percentage. This is considered to be a warning to investors that gains from reinvestment in this sector are slowing. Both software companies and computer companies have started increasing their dividends, reaching to 1.3% from the start of this year. Are tech dividends investment heresy; or appropriate exercises of fiduciary duty by CFOs?

Microsoft: Bellweather of Technology Dividends?

One such example is Microsoft (NASDAQ: MSFT), which has decided to increase its quarterly dividend by 15%. Microsoft has increased its dividend in the past two years and also boosted its dividend payout to around 25% in 2011. Analysts anticipate that the software company will be raising its dividend 3 cents to 23 cents per share. Microsoft has done this for the 6th time since 2004, when it first announced eight cents per share reimbursement to its shareholders.

While this may sound alarming to technology-focused growth investors, some experts are of the opinion that it is in fact a good thing. This can be interpreted in a bullish way: the increase in dividend payouts is the result of tremendous growth in tech sector. The increase in profit has made the chief executive officers of these tech firms responsibly decide to boost dividends and decrease reinvestment as a percentage of earnings. This is nothing new: Microsoft began returning money to its shareholders in March 2003. Income and value investors would view these trends as positive developments.

But, many technology-focused growth investors would beg to differ. Malcom Polley, Chief Investment Officer of Stewart Capital in Indiana, believes that tech companies are slowing down. Mr. Polley oversees $1.1 billion assets under management. He said that historically companies desperately wanted quick re-investment in their businesses because as they were growing rapidly in those days. But, now they have matured and hence, are increasing dividend and payout per share. Many growth investors view this as a warning to investors that these tech companies are no longer growing quickly. In a sense, growth investors view dividend payments as a signal by management that they have run out of promising new projects.

Growth investors can cite many examples where reinvestment has trumped dividend payouts. Microsoft's stock has maintained more or less the same position from the past five years. On the contrary, Google (NASDAQ: GOOG) has taken a more than quarterly leap in these five years while Apple (NASDAQ: AAPL) has reached a quintuple increase. The phenomenal price appreciation in these stocks makes Microsoft shares and their dividend policy look lackluster by comparison.

Therefore, Tuesday’s decision by the board of directors of Microsoft to increase the quarterly dividend has become a cause of worry for growth investors. They are concerned that this decision comes from a lack of attractive new projects in the company, declining financial metrics, and a stagnation in management strategy.

Microsoft shares increased by 1% today and closed at $32 per share. The company is launching its new software Windows 8 in the next year. But, the shares of Microsoft had suffered a decline of about 1% after the announcement was made on Tuesday. But it is important to note that overall the shares of Microsoft have appreciated by 18% in this year.

As for now, things seem to be stable for Microsoft. Heather Bellini, a Goldman Sachs (GS) options strategist believes that Microsoft will not initiate a share buyback in this present fiscal year.  She mentioned that Microsoft has more than $8 billion waiting in the previous share buyback program that was passed by the board.  Thus, many tech companies like Microsoft are forced to return capital to shareholders via dividend increases instead of buybacks because have pending buyback programs.

But whether investors—growth, value, or neither—take the increase in dividend and payout of significant tech companies as a good sign or not, is unpredictable. 

Growth or Value: Crunching the Numbers

Looking at a mix of big technology firms it appears that there is a negative correlation between dividend yields and growth:

Apple and Google have seen the most growth while paying the least dividend yields. Analysts also anticipate higher growth from these companies than other technology firms which pay higher dividends. In this sense, the caution of growth investors about dividends signaling a lack of promising, high-growth projects within a firm seems vindicated.

This means that if you are a growth-fund manager with a mandate that only includes buying growth stocks; you cannot assume “tech” equals “growth.”

But, that does not preclude dividend-paying technology firms from being selected as value investments. Microsoft and Cisco trade at reasonable price-to-earnings ratios while offering dividend yields which trump the 1.8% returns on the 10-year treasury. Furthermore, as an income investment, these stocks are likely to increase their dividend payments over time whereas fixed-rate treasury bills will not.

It should also be noted that despite making new highs in share price, Apple stock remains an attractive investment. Its valuations are reasonable, especially in light of its high growth trajectory. Investors should consider adding shares of Apple to their portfolio as a GARP (growth at reasonable price) play.

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