Dividend Investors Should Boost Technology Exposure, Be Cautious With Energy

by: Alan Brochstein, CFA

What a difference a decade makes! Who would have thought about dividend investors having a choice between Exxon (NYSE:XOM) and Intel (NASDAQ:INTC) back in 2001? Ten years ago, INTC yielded a paltry 0.3%, while XOM's dividend offered a 2.2% return. Most Technology companies didn't pay dividends back then, but many do now, with even Cisco (NASDAQ:CSCO), a notable holdout, recently declaring an initial payment.

Today, several Large-Cap Technology companies offer dividend yields of at least 150% of the 1.8% yield on the S&P 500. Here are thoses names above 2.7%:

  • Paychex (NASDAQ:PAYX) - 3.9%
  • Intel (INTC) - 3.7%
  • Microchip (NASDAQ:MCHP) - 3.6%
  • Linear Technology (NASDAQ:LLTC) - 2.9%
  • Molex (NASDAQ:MOLX) - 2.8%
  • National Semiconductor (NSM) - 2.8%
  • Automatic Data Processing (NASDAQ:ADP) - 2.8%

With the recent run-up in the prices of Energy stocks, these yields compare favorably. In fact, there are only 3 names in the S&P 500 that make the cut:

  • Spectra Energy (NYSE:SE) - 3.8%
  • ConocoPhillips (NYSE:COP) - 3.3%
  • Chevron (NYSE:CVX) - 2.7%

Long a favorite of the widows, orphans and other income investors, XOM has a yield now of just 2.1%. Here is how the dividend yield of XOM compares to that of INTC over time (click to enlarge):

I don't mean to pick on just two stocks, but let's continue with the illustration. Here are some data for INTC and XOM (click to enlarge):

Working through the table, we see that INTC over the past 5 years has grown sales, EPS and dividends more rapidly than XOM. While the payout ratio is slightly higher for INTC at about 1/3 of EPS, it's worth remembering that XOM has a much more capital-intensive business model. I went back for 5 years to adjust income for CapEx in excess of D&A and found that both companies pay out the same 35% of "normalized" FCF.

While XOM has a stellar balance sheet, it's worth noting that INTC has 12% of its market cap in cash and investments while XOM has a small net debt position.

So far, INTC has a higher dividend yield but more historical growth (and both companies have a similar LT outlook from beyond 2011). The dividend as a percentage of free cash flow is similar. In the final three rows, we see various valuation metrics all favoring INTC.

I don't believe that this example is anything but representative. Technology companies are very cheap, with typically strong balance sheets and great cashflow generation. Energy companies typically have strong balance sheets, but they are not as cheap (though not bad) and their cashflow generation is hampered by massive CapEx needs.

Investors have crowded into Energy stocks - they are up almost 17% YTD while Technology is up just 3%. I consider the sector unattractive in the short-term, as the stocks are overbought and extended (due for consolidation/correction). Dividend investors historically haven't had much of an opportunity to consider Technology stocks, but the numbers certainly suggest doing so. In my Conservative Growth/Balanced Model Portfolio, we are underweight energy now after trimming our holding in CVX. We established that position near 70 during the summer and added near 93 in January. We have been building exposure to Technology with holdings in INTC and CSCO and are adding another dividend-payer on Monday. After that trade, 24% of our equity exposure will be in the sector (compared to 18% for the S&P 500).

Disclosure: Long CVX, INTC and CSCO in model portfolios at Invest By Model