Building a Tech Income Portfolio
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
During the 1990s when investors thought of a “tech stock” they thought of it as a high growth, high P/E ratio stock with no dividend. Since the bursting of the dot.com bubble technology companies now trade at a relatively low P/E ratio and not only do they pay a dividend but the yield is quite attractive between 2% to 3%. Even Apple (NASDAQ: AAPL) has P/E ratio of 16 and a dividend yield of 1.6% as of market close Sept. 5 (see chart below). An individual investor can put together a portfolio of tech stocks to build a good income. However, as I stated in a previous article, a high dividend yield has to be sustained by strong fundamentals and prospects.
In evaluating the dividend capability of a company, I consider the total dividend paid out to free cash flow, the total dividend paid out relative to the cash and marketable securities and the traditional dividend to net income comparison also known as the “dividend payout ratio”. I also couple that with fundamental analysis and evaluating the company’s prospects.
Apple’s Rock Solid Dividend
According to Apple’s most recent form 10-Q sales growth was robust across almost all product lines and geographic segments. The highest growing geographic segment was Japan with a 90% growth rate followed by the Asia-Pacific region with 60% for nine months ending June 30. All product lines with the exception of the iPod grew for the first nine months in 2012 versus this time last year. Even Mac desktops grew 1%. iPod sales were down 24%. The highest performing product was the iPad. Apple doubled their iPad units sold compared to the same nine month period last year. Total overall sales increased 51% from $80 billion to $121 billion for the nine month period ending June 30 versus the same period last year.
Recently this company started paying a dividend of $10.60 per share per year or $2.65 per quarter, about a 1.6% yield. With robust growth in sales and product volume this company shouldn’t have a problem sustaining this dividend and maybe even increasing the dividend in future years even assuming lower growth.
Here’s a look at their dividend capability:
A $2.65 dividend multiplied by 944 million shares gives you roughly a $2.5 billion dollar payout for the quarter. This equates to 7% of the free cash flow generated for the 9 months from Apple. This also equates to about $10 billion a year in total dividend payout. I estimate (or guess) that this will be about 21% of free cash flow for the year assuming that free cash flow will be around $47 billion dollars. My personal threshold for dividends to free cash flow is 40%, a little higher if there is plenty of cash on the balance sheet. Ten billion dollars a year currently equates to 36% of the cash on Apple’s balance sheet. Dividends to cash, short term and long term marketable securities are only 7%. The dividend payout ratio or dividend to net income is 28%. Apple is dividend capable.
Microsoft’s Large Cash Cushion
Microsoft (NASDAQ: MSFT) is a value investor’s dream. Its P/E ratio is 15 with a dividend yield of around 2.6%. This yield is definitely higher than any savings account interest rate available today. However, investing in stocks carries a greater risk. This means that the dividend paid by Microsoft is not guaranteed.
Microsoft is experiencing declines in some of their segments. The revenue in the Windows and Windows Live division has declined mainly due to lower prices of Windows in emerging markets and deferral of revenue pertaining to the Windows upgrade offer. Their operating income declined because of increased research and development costs associated with Windows 8. Also the average consumer is probably delaying purchases of Windows products until the release of Windows 8. Its online service division grew their revenue but operating losses continue to increase.
The divisions associated with productivity were up in FY 2012. The revenue and operating income of Microsoft’s business division were both up 7% during FY 2012. Microsoft’s server and tools division increased their revenue and operating income 12% and 18% respectively.
Microsoft’s dividend capability:
Microsoft paid out $6.4 billion dollars in dividends in FY 2012. This equates to about 22% of the free cash flow or about 10% of its $63 billion in cash and short term investments. The dividend payout ratio is 38% for FY 2012. Goodwill impairment lowered net income but didn’t affect free cash flow. Free cash flow grew 34% in FY 2012. There is still life left in Microsoft assuming that the new Windows 8 operating system pans out. The 2.60% should be sustainable.
Questionable Dividend Sustainability
Some company’s dividend capabilities are questionable if not downright unsustainable. Intel (NASDAQ: INTC) paid out $2.1 billion dollars or about 102% of its free cash flow for six months ending June 30. Its dividend payout ratio is 38%. Intel’s yield is about 3.6% as of Sept. 5. This only equates to about 23% of cash on hand so this dividend will probably be okay as long as they can keep growing their free cash flow. All of their segments reported increases in revenue except the “Other Intel Architecture Operating Segments” according to the company’s latest form 10-Q. Research and development costs are on the rise which means they are in the process of building newer and better products. However, year to date FY 2012 free cash flow has decreased 25% versus this time in FY 2011.
Hewlett Packard (NYSE: HPQ) is a company that is having trouble in just about all of its segments according to the latest earnings announcement. It has a dividend yield of 3% as of this writing on Sept. 5. However, all but two segments declined year to date in FY 2012. The dividend payout ratio is incalculable because it turned a loss for the quarter ending July 31. Hewlett Packard’s dividend to free cash flow was only 19% and about 9% of its cash as of July 31; however, due to deteriorating fundamentals I would doubt that the dividends coming from this company can be sustained.
As long as a company has strong fundamentals, good prospects, generates and keeps cash it should be able to sustain and grow its dividend. If a company is paying out all of its free cash flow and has deteriorating fundamentals then the dividend will most likely be slashed and the investor will be stuck with subpar returns. So, when building a tech income portfolio, as when building any stock portfolio, tread with caution.
stockdissector owns shares of Apple, Intel and Microsoft. The Motley Fool owns shares of Apple, Intel, and Microsoft. Motley Fool newsletter services recommend Apple and Intel. 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.If you have questions about this post or the Fool’s blog network, click here for information.