Why Are Tech Companies Turning to Dividends?

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 |  Includes: INTC, MSFT, QCOM
by: Dr. Stephen Leeb
Corporations, especially in the tech sector, continue to borrow money today. Why not, with interest rates so low? But, as the New York Times pointed out today, they're not spending their borrowed cash on business expansion.
For example, Microsoft (NASDAQ:MSFT) recently announced a plan to borrow over $4 billion dollars. It doesn't need the money for research and development or even advertising. Instead, Microsoft has adopted the radical idea of enhancing shareholder value, and will put the money towards stock repurchases and dividends.
Another company that has converted to the philosophy of rewarding investors is Cisco, which has also initiated a dividend program. Intel (NASDAQ:INTC) – a company which we have long held as a growth stock, but may be losing that status – already offers a dividend yield of 3% (a pretty hefty rate these days).
If these companies were utilities, none of this would seem surprising. But these are technology stocks! They're supposed to be spending all their cash bringing new innovations to market so they can rapidly grow their revenues.
Why this sudden concern with dividends? One clue is found in the SEC's recent finding that the Dow's 1,000 point mini-crash on May 6th this year had nothing to do with high-frequency trading. The supposed trigger was an institutional order that was carried out essentially all at once when it would normally be executed over a period of hours.
To be clear, this was not a particularly large or unusual order. As for why it had such a big impact on the market, two possibilities exist. First, it may have been simply one of those anomalies that arise when markets become overly complex. High frequency trading and enormous amounts of data create a less stable environment. The other possibility is that someone hacked into the system. If so, we'll probably never know whether the culprit was a teenaged prankster or a foreign espionage agent.
Regarding the latter, you may have read the news last week about the Stuxnet worm that has infected corporate computers around the world – and especially in Iran. Initial findings suggest that someone – possibly the U.S. and/or Israel – may have designed the worm as an attack on Iran's nuclear facilities. Regardless of how you see this worm – as either an attempt to prevent a nuclear event or cause one – it shows the kind of danger that every nation must now protect itself against.
Both these events – the mini-crash and the Stuxnet worm – are examples of vulnerabilities stemming from today's data-heavy world. Where more data once helped us solve problems, now it increasingly causes more of them. Information technology may be nearing the limits of its usefulness.
Once upon a time, IT was a hot new tool. It gave scientists easy access to large amounts of data that presumably could help them discover new insights – or at least speed up their work.
However, while computers will continue to serve that role, their technology is maturing. Computers can deal with more data today than they could six years ago, but that's only because today's computers use more chips. Chip speeds have hit a wall and are no longer increasing.
What's more, far from producing new breakthroughs at a faster pace, science is slowing down. Scientific progress is becoming scientific stasis. Wikipedia (today's repository of popular knowledge) refers to the cracking of the human genome in 2003 as, “an important step in the development of medicines,” yet no new medicines have actually been developed because of it. We were particularly alarmed by a recent article in Nature which pointed out that the best treatment for Parkinson's disease today is still L-DOPA, which was introduced in 1960. Fifty years of research. Progress: none.
To be fair, there are a number of researchers who may be on the verge of breakthroughs in treating Parkinson's disease. But these breakthroughs are mainly the result of human intuition. They are occurring in spite of rather than because of information technology.
Meanwhile, we are becoming ever more dependent on computers. We use them not as one of many tools but as the central focus of our research. And it's not working.
Alan Lightman, in his book Discoveries: Great Breakthroughs in 20th Century Science, catalogs the 22 top scientific discoveries of the past 100 years. The most recent was made in 1978, a time when desktop computers were rare and not very powerful.
Don't get us wrong. We're not Luddites. Our office could not function without computers. As I write this (on a computer), I'm sitting before a bank of four monitors displaying the up-to-the-second data on the markets. Yet, I have to confess that the best research I do isn't done online. My best ideas come from following up on intuitive insights and my own curiosity.
To give you another example... 20 years ago or so I used to lunch regularly with a highly successful investor named Roy Neuberger. He was more than 80 years old at the time (he's over 100 now). Mr. Neuberger was an extraordinary man who certainly loved computers, even back in the 1980s, and used them to chart stocks. At the time, the leading stocks included Coca Cola (NYSE:KO) and Wal-Mart (NYSE:WMT). Yet for some reason, he disliked both those stocks intensely. He never went long on them, and shorted them whenever he sensed a good opportunity. Both these stocks remained in powerful uptrends for many years. Yet Neuberger consistently made money by selling them short. His instincts were better than any computer could ever generate.
Similarly, you will never find the best innovative chess moves generated by a computer. Despite what you may have heard, human creativity is far superior to any computer software. Computers may win against most human players, because they have no psychological weaknesses or time constraints. But a computer's reliance on number crunching over real insight means it will never be the best chess player in the world.
At this point, you may be asking what this has to do with investing. Well, our point is that technology – based as it is on information technology - is no longer a growth industry. Technology shares on average are priced at a fraction of their 2000 highs. The fact that technology companies aren't spending money on R&D tells you they have little hope of making new innovations.
The silver lining, however, is that tech stocks are great companies in today's market because they are becoming more like utilities. They will still enjoy some growth, as technology spreads around the world, though it will be slower than in the past. Even better, the total returns (growth + dividends) from many tech companies will be quite healthy.
Recently we surveyed nine of the leading companies in semiconductors and related technology. Their average dividend yield is about 2.7% - pretty good now that interest rates are very low. But what really drew our attention was that their average free cash flow yield (the highest yield they could theoretically afford to pay) is 8.5%. That leaves a lot of room for dividends to increase. What's more, while these companies' earnings grew an average of 4% during the past five years, their dividend growth averaged 22%.
We expect dividend growth to outstrip income growth for some time to come. Current dividends are likely to grow very rapidly. In other words, leading tech stocks like Microsoft, Qualcomm (NASDAQ:QCOM), and Intel are now total return stocks. They may not make you rich. They probably won't grow at double-digit rates for much longer. But their rising dividends will make them an important source of investment income.
We've talked a lot about how quickly the world is changing. This is one more change you need to recognize and take advantage of. For your income portfolio, tech stocks are the new utilities.