Three Midcap Tech Stocks with Rising Dividends

Ask a dozen investors where to find good dividend-growers, and if any reply “midcap technology stocks” you’ll probably wonder whether you should break out the Breathalyzer and ask for their car keys.

But maybe those folks aren’t as wobbly as they seem. Though it’s true that diehard income investors won’t find high enough yields here, they might benefit from the income growth, diversification, and capital appreciation potential. Additionally, investors who don’t usually focus on dividends could find that in a volatile area like midcap technology, consistent dividend-growers have attractive characteristics, especially in uncertain markets.

More on all that later. But first, three good examples of dividend-growing midcap technology stocks: Harris Corp. (HRS), a communications technology firm; and Factset Research Systems (FDS) and Jack Henry & Associates (JKHY), both data processors.

Starting with a snapshot of some common fundamentals, all three stocks remain reasonably valued compared to their historic Price to Earnings, Sales, and Cash Flow ratios, based on data from Morningstar and MSN Money. HRS does sport a nosebleed P/E on Yahoo Finance from recent write-offs, including spinning off an underperforming division whose core competency appeared to be creating earnings disappointments. Good riddance.

All three of these midcap techs also have clean balance sheets and attractive internal rates of return, with no long-term debt and ROEs ranging from 15% to 30%.

Finally, though hardly exempt from poor market and business conditions, all three kept raising their dividends during the ugly market Morningstar called the worst period for dividend cuts since 1938.

So how do their dividend and growth metrics stack up?

HRS currently yields 2.3%, though I anticipate a dividend increase announcement within days, marking eight straight years of increases.

And if this year’s increase is anything remotely like recent ones, expect the stock’s yield to go up: last September HRS raised the dividend 33%, roughly in line with their past 3-year average of 36%. These increases were supported by 3-year EPS growth of 31%, which was driven by revenue growth of 21%, all based on Morningstar data. The payout ratio is 34%.

Besides hiding in the dividend hinterlands of midcap tech, with eight years of dividend growth HRS doesn’t appear on popular 10-year grower lists, further camouflaging it from many dividend-growth hunters. The market liked the company’s latest quarterly release, sending the stock up 12%.

But no more yield hogging here: FDS and JKHY both yield 1.4%.

This May, with its 11% boost for 2009, FDS notched ten consecutive years of dividend increases. This increase was well below their stunning 3-year average of 45%, but with 3-year EPS and revenue growth of 21% and 23%, respectively, and the wreckage in their Wall Street customer base, it would be surprising for FDS to maintain their torrid pace of past dividend growth.

Still, the payout ratio is just 25%, so there certainly seems room for dividend growth in line with earnings, which will likely turn up as the market recovers. In their latest quarterly release FDS reported higher revenues, earnings, cash flow, margins and guidance, but some forward-looking revenue indicators declined.

Finally, JKHY is my personal poster child for dividend-tenacious management. After over a decade of annual increases, the 2001-2002 capital spending slowdown convinced the Board to simply maintain the 2003 dividend, prompting management to all but apologize in the accompanying news release. JKHY then increased the dividend in 2004, and every year since, including a 13% pop this year. The 3-year average is 18%, supported by EPS and revenue growth of 13% and 12%, respectively. Payout ratio: 26%.

Like HRS, JKHY doesn’t appear on well-worn dividend-grower lists, its 2003 lapse cursing it with a merely near-perfect record for nearly 20 years. Those who worry that JKHY’s real curse is its regional bank clients might take comfort in Morningstar’s assessment that the core, non-discretionary nature of JKHY’s services is a solid source of recurring revenues.

Still, banks are banks, so there’s no denying the business risk. In their latest quarterly release (see conference call transcript here) JKHY reported increased revenue and earnings, and a strong enough 2010 outlook to send the stock up 5%.

There’s also no denying that some dividend investors will consider these stocks’ yields pitifully low. But the income growth from them is not. After two years, a stock with a 1.7% yield and 18% dividend increases will generate nearly twice as many dollars of income growth as a 6% yielder growing at 3%. And the gap between them keeps widening from there. (For this illustration, the 1.7% and 18% are conservative averages of the yields and one-year increases for the three stocks discussed above. The 6% and 3% are pure illustration.)

Stocks like these can also provide diversification for dividend investors who find their portfolios tilted too defensively, or too concentrated in large companies or traditional high yield industries. And the capital appreciation potential for stocks with many years of growth ahead can provide substantial capital gains opportunities over the long run.

Lastly, there are benefits to owning dividend-growers like these, even if you don’t want the dividends (mail them to me). Paying out more and more cash to shareholders each year, while still growing the business, takes a healthy company with disciplined management and a solid business model. BusinessWeek magazine cited research showing that stocks with at least five years of dividend growth outperformed the market every year from 1972 to 2008 (“Follow the Juicy Dividends,” February 23, 2009).

In general, dividend-growers can provide high performance with low volatility, and the three stocks profiled here outpaced both the S&P 500 and MidCap ETF (MDY) over the past five years. Granted, you don’t get the upside of the next biotech lottery ticket, but you don’t get the downside either.

And who knows? If you do your homework and find something you really like, maybe someday someone will ask you where to find good dividend-growers. And you can say “midcap technology stocks” and still hold onto your car keys.

Disclosure: Long FDS, HRS, JKHY

Comments

[Low Sweat I...:]

CORRECTION: HRS Long-Term Debt

My article reported all three of these stocks have no long-term debt. HRS had $827,500 of long-tem debt as of the April quarter, compared to nearly $2.2 million in shareholder equity. I regret this error.

Aug 25 02:59 PM

[Brad Castro:]

Interesting article. Thanks for the fresh perspective, good analysis, and entertaining writing (although I won't be mailing you any dividends).

Aug 25 04:48 PM

[Low Sweat I...:]

On Aug 25 02:59 PM Low Sweat Investing wrote:

CORRECTION: HRS Long-Term Debt

My article reported all three of these stocks have no long-term debt.

HRS had over $827 million of long-tem debt as of the April quarter, compared to nearly $2.2 billion in shareholder equity. I regret this error.

Aug 25 05:37 PM

[Low Sweat I...:]

Thank you for your kind words.


On Aug 25 04:48 PM Brad Castro wrote:

> Interesting article. Thanks for the fresh perspective, good analysis,
> and entertaining writing (although I won't be mailing you any dividends).

Aug 25 05:38 PM

[Low Sweat I...:]

‘INCOME GROWTH’ MATH

I found recently that it can be confusing to refer to income growth the way I did in this article. To clarify, I referred in the article to dollars of income growth: incremental, new dollars from the dividend growth rate. Not total income or yield on cost.

Here’s an illustration of that income growth: a 1.7% yielder generates $170 the first year on every $10,000 invested. So at 18% dividend growth, that is nearly $31 of new, incremental income after the first year (on every $10K invested in such stocks), and over $36 after the second ($201 * 18%).

Every $10K in 6% yielders generates $600 the first year -- much more total income, of course. After the first year there’s also $18 in new, incremental income from the 3% dividend growth. Then after the second year, there is less than $19 of new income ($618 * 3%).

And the differential in the dividend growth rates will widen the gap in new, incremental dollars of income, year after year.

So who cares about dividend stocks that crank out more dollars of income growth?

Investors whose balanced portfolios already generate sufficient base income, but won’t produce much future income growth because their bond coupons are fixed and future dividend growth and capital appreciation will likely be low;

Income investors who feel their stock portfolios are too concentrated in traditional high yield industries and so could benefit from diversification into higher growth sectors, but who still want some dividend benefit;

Dividend investors who view strong dividend growth as a sign of a healthy company with disciplined management and a solid business model, but are more interested in capital growth than current income.

I hope this post is a helpful explanation of what I confess might seem like an obscure metric.

Sep 22 12:26 PM

[jculley:]

I have been reading SA for a while now and somehow missed your articles. I am certainly glad I found them, as these three stocks are now on my "further research" list and will hopefully make it onto my watch list.

Excellent article, and so are all the other ones I had to go back and read to get caught up on your market take.

Sep 24 02:37 PM

[Low Sweat I...:]

Thank you for your kind words. I'm glad you found the article helpful.

If possible, I would be interested in hearing via a comment what your research turns up. I own these stocks and always like to get additional perspectives on them, and on other dividend-growers as well.

On Sep 24 02:37 PM jculley wrote:

> I have been reading SA for a while now and somehow missed your articles.
> I am certainly glad I found them, as these three stocks are now on
> my "further research" list and will hopefully make it onto my watch
> list.
>
> Excellent article, and so are all the other ones I had to go back
> and read to get caught up on your market take.

Sep 24 07:21 PM