Rise of the nerds – tech stock dividends

Technology stocks are the largest dividend payers in the S&P500. Really? Yes. With the significant raise in Cisco’s (CSCO) dividend last week, the technology sector became the largest paying dividend sector, on a percentage basis, of all the S&P500 industry sectors (see this article). Apple’s (AAPL) initiation of a dividend earlier this year didn’t hurt either. Lets dig down a little deeper into this development and see what that could mean for income investors.

First, this development has been coming for a while. I first posted on this trend almost 2 years ago now. Basically, the tech industry is maturing, growth rates a slowing, and thus companies don’t  need as much capital to redeploy to support growth. This is all pretty normal for an industry. This means higher free cash flows and the ability to return more cash to shareholders. But at the same time you still get pretty decent growth rates. As the WSJ article linked above says

Technology is typically characterized as a volatile, high-flying cyclical sector, which tends to see prices swing more wildly than more defensive-minded sectors. But now the tech sector’s dividend payouts combined with its growth rates could make it even more attractive.

I agree that tech sector dividends could potentially present income investors a great opportunity to find decent dividend yields but more importantly great dividend growth. The problem for most income investors is the volatility of the tech sector. The sector still has much of the volatility associated with growth stocks. The ETFs that track the sector or sub-sectors, such as QQQ, NDX, XLK, SMH are quite volatile and the dividend yields aren’t great overall. So, first and foremost, investing in individual stocks is the best way to take advantage of this trend.

The first place I always go look for great dividend stocks is the dividend champions list that I’ve posted on before. Taking a quick look through the 473 stocks on the list you’ll find 25 tech stocks. Pretty much as expected since this is a relatively new trend. Only 2 tech stocks have raised dividends for 25 years or more, AT&T (T) and Telecom Data Systems (TDS), both telecommunications companies. The newer entrants, at least 5 years of dividend increases, are concentrated in telecommunications and semiconductors. Companies like Verizon (VZ), Intel (INTC), and Texas Instruments (TXN). Outside of this list of stalwart payers, using a good stock screener like finviz, you can find 92 companies in the tech sector that have a dividend yield of 3% or more. Not bad. Personally, I like to look at the younger tech dividend payers as they tend to have higher dividend growth rates. More conservative buy and hold investors can stick with some of the big telecom names like T and VZ who are discovering new avenues of growth via the wireless sector. But is there a way to deal with or take advantage of the volatility in the tech sector? I think so.

A big portion of the tech sector tends to exhibit seasonality, i.e. it does better during certain times of the year than others. For the tech sector the second half of the year tends to be more positive than the first. This is not too surprising if you think about it. Most of the big holidays are in the second half of the year and also there are some other big events that can drive tech sales such as back to school and Chinese new year. I experienced this first hand in my almost 20 years working in the tech sector. For some hard numbers as to the level of out performance in the latter part of the year see this article. The table below shows SP500 sector performance during the September to December (4 months) period over the last 10 years.

Returns of 5.7% on average over a 4 month period is over  17% annualized. An investor can put tech sector volatility on their side by exploiting these trends. Just remember these are tendencies and probabilities, not certainties. Seasonality didn’t help tech stocks during the financial crisis.

My personal approach is to look to ride this positive seasonality by trading individual tech stocks with good technical setups if the market trend is on my side. Right now the market trend is positive, rising 50 and 200 day SMA with prices well above both. I think the tech season is a bit longer than the chart above shows so I start to look in mid to late August and look to ride the positions into the end of January usually. My favorite plays right now are AAPL and CSCO. Both are now decent dividend payers, have lots of room for dividend growth, and are just breaking out of some key technical patterns that suggest some decent returns at least through the end of the year.

In summary, the tech sector can no longer be ignored as a source of dividends. It has become the largest dividend paying sector in the SP500 and offers the potential for good dividend growth as well. The sector offers something for conservative and aggressive investors. Conservative investors can focus on some the telecommunications stalwarts such as ATT and Verizon. Aggressive Investors can take advantage of seasonality in the tech sector by taking a shorter term outlook and trading some tech stocks during the final months of the year.

Disclosure: long AAPL and CSCO