Is Technology a Haven for Dividend Investors?

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Technology stocks used to be known for two things: extremely high growth and no dividends to shareholders.  Neither is entirely true anymore -- many large-cap tech stocks now have very modest valuations, sometimes lower than that of the broader market.  Add to that the fact that many tech stocks not only now pay dividends, but often have yields better than the yield on the S&P 500, and the technology sector looks like a great place for value and dividend investors to allocate capital.

Microsoft (NASDAQ: MSFT) is a $232 billion behemoth that provides software products and services worldwide.  Microsoft recently released fiscal second-quarter results, which saw net revenues increase 3%, while earnings per share decreased 2.5% versus the same quarter a year ago. 

Microsoft is a solid operating cash flow generator and is trading at a modest Enterprise Value-to-EBITDA ratio of just 6 times.  The company has clearly demonstrated its transition to a company that aggressively returns cash to shareholders: the stock yields almost 3.5% and has raised its dividend at a compound annual growth rate of almost 16% over the last five years.

Cisco Systems (NASDAQ: CSCO) is a fellow mega-cap with a market value of $111 billion.  Fiscal 2012 sales were up more than 6.5% while diluted earnings per share rose 27%. 

Taking a longer view, Cisco’s results since 2008 haven’t been as impressive.  Compound annual growth of revenues and diluted EPS stands at less than 4% each over the last four years.  Cisco made some costly mistakes, entering product areas that were outside its core competencies, such as with the Flip camcorder. 

To engineer a turnaround, CEO John Chambers promised a return to the high-margin business lines investors had long expected.  Investors who believe in the turnaround story will enjoy both steady cash flow generation and solid shareholder return.  Cisco is a new entrant into the dividend-paying universe, having paid its first distribution in 2011.  Nevertheless, Cisco has more than doubled it since that time, and now provides a solid yield of 2.67% at current prices.

Speaking of turnarounds, there is perhaps no better example than Hewlett-Packard (NYSE: HPQ).  The company’s fall from grace has been well-publicized.  After trading north of $50 in early 2010, HP began a nearly unimpeded decline down to its current level of the mid-teens.  Revenues have stagnated, increasing at only a 2.9% rate compounded annually over the last five years.  The company reported a massive loss of $6.41 per share in 2012, due to higher operating expenses and a huge $18 billion impairment charge. 

On a positive note, Hewlett-Packard continues to be a strong cash flow generator, producing more than $6.8 billion in free cash flow in fiscal 2012.  HP uses part of that cash flow to pay a dividend to shareholders, which it raised 10% in 2012 and now yields better than 3%.

The Bottom Line

The transition from a high-growth stock to a value stock is usually a painful one, particularly for technology stocks.  Many growth investors left these stocks long ago, and in their place, value investors have been slow to rush in.  As a result, these companies trade at attractive multiples of their free cash flow.  In addition, each pays a dividend that beats the yield on the market.  Consequently, value and income investors alike would be wise to add these stocks to their watch lists.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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