Look To Tech For Big Dividend Potential

By Aaron Levitt | Updated September 02, 2014 AAA

Investors looking for dividend growth and hefty payouts are often drawn to the utility, consumer staples and even healthcare stocks. After all, the trio’s stable and relatively recession-resistant natures help them churn out plenty of cash flows and big dividend yields.

Well, you can now add the technology sector to that list of dividend stalwarts.

While the “hyper growth” of the dotcom days can still be found, the majority of the technology sector has matured into a stable, cash-flow-heavy machine. And that means a fertile hunting ground for dividend stock lovers. For investors, the time to bet on the sector’s income opportunities is now.

Rising Dividend Growth

During the dotcom bubble of the 1990’s, tech was all about growth, growth, growth – sometimes at the cost of profits. These days, the survivors of the dotcom boom/bust are now producing record profits and cash hoards. Perhaps more importantly, they're beginning to return those dividends to investors in spades.

When PowerShares QQQ (Nasdaq:QQQ) – which tracks the Nasdaq 100 index – was surging during the dotcom days of 1999, its dividend yield was a paltry 0.9%. Today, more than half of QQQ’s constituents now pay dividends and the ETF yields more than 1.43%. The same can be said for the tech firms in the S&P 500. According to analysts at S&P Capital IQ, the reason is quite simple – mature tech firms already have more money than they know what to do with. The sector, on average, features more cash on its balance sheets and less debt than any industry in the S&P 500. That includes traditional stalwarts like utilities and consumer staples.

This results in an environment where tech can payout the big bucks and significantly grow those payouts further.

Already tech is quickly taking the dividend growth crown away from other sectors. For example, Apple (Nasdaq:AAPL) – which only began paying a dividend a few years ago – is already the second-biggest dividend payer in the S&P 500. Over the last 10 years, tech has managed to grow its average dividend payments by nearly 25%. That’s about 10% more than the next closest sector – consumer services – and 19% more than last place financial stocks. What’s more, the technology sector's average payout ratio of free cash flow was just 20%. This compares to 36% for the entire S&P 500.

All in all, that means dividend boosts could be down the line for investors.

Scoring Some High Tech Dividends

With tech now showing growth and dividends, the time to pounce could be now. Perhaps even more so, when you consider the sector can be had for a cheaper P/E ratio than the rest of the S&P 500. Simply buying the popular Technology Select Sector SPDR (NYSE:XLK) nets you a 1.81% yield and P/E of 15.

A perhaps better broad tech dividend play is the First Trust Nasdaq Technology Dividend (Nasdaq:TDIV). The ETF tracks 87 different tech companies – weighted by dividend paying ability and value. Top holdings including firms like Microsoft (Nasdaq:MSFT) and Oracle (NYSE:ORCL). This focus on the biggest and strongest tech dividend payers produces a hefty index yield of 3.19%. That’s impressive considering that tech, just a few years ago, wasn’t really paying anything.

Another fertile ground for big tech dividends can be found in the manufacturers of semiconductors. Forming the backbone of modern technology, semiconductors are found in nearly everything these days – from computers and tablets to washing machines and toasters. That provides their producers with some pretty stable cash flows. Chipmakers KLA-Tencor (Nasdaq:KLAC) and Microchip Technology (Nasdaq:MCHP) yield an average of 3%, while the broad Market Vectors Semiconductor ETF (NYSE:SMH) has a trailing 12-month yield of 2.51%.

Another interesting tech dividend play could be payroll-processing outsourcers Automatic Data Processing (NYSE:ADP) and Paychex (Nasdaq:PAYX). Both firms continue to churn out hefty profits as they make money off “float” from holding businesses' cash before it’s paid to employees. Meanwhile, new cloud computing HR applications provides plenty of future growth for the two firms.

The Bottom Line      

Historically, the technology sector hasn’t been known for its dividend prowess. However, that is rapidly changing. For investors, the sector offers some of the best and quickest growing yields around. The previous picks – along with high yielding CA Technologies (NYSE:CA) – make ideal selections to play tech’s dividend punch.

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