Low bond yields have led investors to seek out reliable dividend paying stocks as alternatives to fixed income investments. Investors are understandably interested not only in the current dividend yield a given stock pays, but also in the security of knowing that the dividend is not likely to be reduced, and, in fact, is likely to be increased.
Dividend investors often examine the "pay out ratio" (the percentage of earnings being paid out as dividends) in this regard. A stock paying out a very high percentage of its earnings as dividends bears a risk that if earnings decline, the dividend may be unsustainable. This article suggests an alternative approach to dividend security analysis, which points strongly in the direction of certain tech stocks as attractive investments for dividend investors.
Microsoft (NASDAQ:MSFT), Cisco (NASDAQ:CSCO) and, to a lesser extent, Intel (NASDAQ:INTC) have built up significant piles of balance sheet cash in the last few years. This cash can, of course, be used to pay dividends - even at a time when current earnings are in decline. Thus, investors in these stocks have, in a way, a "second line of defense" against dividend cut backs. It is interesting to quantify this in comparing these stocks with other stocks often favored by dividend investors.
For each stock, I am going to provide Friday's closing price, trailing earnings per share, current dividends, dividend yield, pay out ratio, number of quarters of dividends covered by gross balance sheet cash, and number of quarters of dividends covered by net balance sheet cash. The last two calculations are new metrics and are simply based on dividing the current amount of quarterly dividends into the relevant balance sheet cash number. It gives the investor a sense of how long the company could keep paying its dividends without borrowing money if earnings went to zero.
1. Cisco - (17.30) (1.49) (.56) (3.2%) (36%) (64) (44) - CSCO is really the champion of this group. As I have written before, I think the balance sheet understates the cash pile because of the financing of accounts receivable, but I used conventional balance sheet cash calculations. It is remarkable the CSCO could pay dividends for 16 years out of balance sheet cash if earnings went to zero. I am 68 years old, and 16 years from now, I will forget anything I said in this article. I don't want to make a rash pledge and turn out like Robert Kennedy when he promised to jump off the top of the Capitol Building if Jimmy Hoffa was not convicted and had to sheepishly accept a parachute as a joke gift from Edward Bennett Williams when he got Hoffa off. However, I think that this is a very, very secure dividend and I would be willing to attend a small (and hopefully short) cocktail party wearing a sign saying "I am the Idiot who thought Cisco's dividend was secure" if the dividend is cut. CSCO also has a relatively low pay out ratio. While its market position is constantly under siege, it is not particularly vulnerable to whims of retail consumers.
2. Microsoft - (29.50) (1.85) (.96) (3.1%) (51%) (40) (34) - The world is holding its breath to see how the latest version of Windows fares and how well MSFT's new entry into the tablet market goes. Initial reaction seems positive, but these markets can be fickle. What is striking is that even after a major acquisition, MSFT's balance sheet provides a backstop sufficient to pay dividends at the current rate for ten years. The payout ratio probably understates dividend security because MSFT, like CSCO, persistently operates with depreciation and amortization in excess of Capex and so cash flow is enormous.
3. Intel - (22.06) (2.29) (.90) (4.1%) (39%) (13) (8) - INTC will probably be the most controversial of the group. It clearly has the least balance sheet protection of its dividend. It also has faced some projections of declining earnings in the next year or two. INTC spends an enormous amount on R&D and has not built up the kind of cash that the other two have. For all of these reasons, it trades at a higher dividend yield - well over the interest rate on 30-year Treasuries. I have read debates on INTC's future prospects and they quickly devolve into discussions incomprehensible to anyone not expert in the field of microprocessors. As a dividend investor, I would probably go light on this one in weighting but the yield, strong balance sheet, and market position are very attractive.
Adding these stocks to your dividend portfolio is not without risk. They operate in an ever changing industry and so they are faced with the constant danger of market share loss and "disruptive" technological innovation. On the other hand, the saturation level of computers, tablets, smart phones and even internet usage is still relatively low in the developing countries and there is every reason to believe that the tech industry as a whole will experience robust growth. Add to this the balance sheet strength and I believe that you have positives which more than offset the risks.
And there are risks whichever way you turn. Some dividend investor favorites like Procter & Gamble (NYSE:PG) are trading at elevated price earnings ratios. Others like Verizon (NYSE:VZ) and AT&T (NYSE:T) sit atop mountains of debt. Including MSFT, CSCO and, perhaps to a lesser extent INTC diversifies your risks.
One final point. In articles about dividend stocks and other yield oriented strategies, I often get comments asking what the impact of higher interest rates will be. One advantage of stocks with huge amounts of balance sheet cash is that those stocks will experience an automatic earnings tailwind if interest rates increase. Not a big deal but not trivial either - especially in the case of CSCO and MSFT.
Disclosure: I am long CSCO, MSFT, INTC, PG, T, VZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.