EquitiesOct 29 2012

Should income seekers turn to technology funds?

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As bonds offer historically low yields, the technology sector is increasingly being viewed as a credible alternative in the hunt for income.

Industry experts believe the sector is an overlooked yet lucrative source of dividends, and should not be viewed as only suitable for growth investors.

In the boom days of the 1990s, technology companies rarely gave an income and instead concentrated on growing at a lightning-fast pace that meant any capital had to be reinvested back in to the business. However, as the sector has become more established, investors have increasingly sought regularity of return and there are signs the market is responding to this.

Rising dividends

Following the passing of founder Steve Jobs, who famously refused to pay out to investors, Apple issued its first dividend since 1995 in August this year, of $2.65 per share. Cisco, the network equipment manufacturer, pushed its dividend up 75 per cent in the same month, causing its stocks to jump 9 per cent, and Microsoft has consistently grown its dividend since 1993.

Although tech giant Google still pays out nothing at all, there is evidence its growth is slowing, suggesting it may follow suit.

These factors helped technology stocks to proportionately give the highest dividends of any large cap sector in the S&P index, according to Howard Silverblatt, a senior S&P analyst. They are set to pay out $45.10 per share in total dividends over the next year, according to Bloomberg data released in September, a record high for the technology sector.

Fran Radano, is senior investment manager on the Aberdeen North American Income Trust, which has information technology as its fourth largest holding. He believes technology companies are “belatedly beginning to admit their age.”

“Apple, while admittedly is still in its growth years, has a mountain of cash, some of which it has finally returned to investors. As time goes on we would expect other tech companies to commence paying dividends,” he said.

Peter Vanderlee is manager of the Legg Mason US equity fund, of which 12.56 per cent is technology stocks, with Apple as the second largest holding. He agreed that technology companies have shifted their perception of dividend pay outs, but said there is still a long way to go.

“These companies have the finances to increase the dividend. If you look at the payout ratios you see that in general technology stocks pay out very low, around 20 per cent on average,” he said.

“Tech companies have been historically reluctant to embrace dividends in the belief that it’s some kind of signal that growth days are behind them but if anything the market responds well to any meaningful dividend release. This puts pressure on other companies to follow suit, with shareholders like myself questioning the managers about their asset allocation,”

He believes any stigma attached to releasing a dividend has relaxed.

“The preconception in the Silicon valley that dividends aren’t a good thing has shifted. Where before tech stocks attracted mainly growth investors, the increase in dividends means they are attracting a more diverse shareholder base,” he said.

Broadening horizons

The manager pointed to the baby boomer generation, who are looking for growth income and capital preservation in their retirement years and increasingly turning to technology stocks that offer a reasonable yield and a competitive dividend.

Ben Seager-Scott, senior analyst at discount broker firm BestInvest, said he thinks technology companies have already got the balance between growth and income about right:

“It would be a bad signal if these companies gave too much away in their dividend because they would feel like they were no longer investing in research and development.

“Good tech stocks give back and reinvest so they can carry on growing. After all, it would be pointless for investors to sacrifice their capital.”

He agreed with Mr Vanderlee that a dividend payout was no sign that a company had stopped growing.

“It is a positive sign for companies to grow their dividend because it shows investors that the board is not planning on going on any kind of mergers and acquisitions spree. Plus, from the point of view of investors it adds to total return.”

The analyst believes technology stocks are in a process of “migration” from high-risk, specifically tech-orientated portfolios to being more at home in mainstream, equity income funds.

“While I don’t think individual investors will be attracted to tech stocks, general income funds are because it offers a chance to diversify their portfolios,” he said.

However, Martin Bamford, managing director of financial adviser firm Informed Choice, said it is still too soon for him to recommend technology stocks to his clients from an income perspective.

“I believe that some of the more high profile stocks are bad value because they are in a bubble at the moment. Look at Facebook: it’s always a mistake to apply value to a loss-making company.

“A lot of the big technology firms are American-based and there is not so much of a dividend culture there as there is in the UK because traditionally these companies have preferred to retain cash for acquisitions. In the longer term though, tech stocks could prove to be an opportunity as they develop cash reserves and find less opportunities for development.”

Gavin Haynes, managing director at Whitechurch Securities, agrees it may be too soon for investors to associate technology companies with income, but suggested the tide may be turning.

“This is an industry where companies are maturing. With interest on cash stocks and bonds so low, investors are turning to equity for income and putting the pressure on. I certainly expect to see an increase in this dividend trend.

“However, lots of people had their fingers burnt in the late 90s by the burst of the tech bubble and so perhaps still have that preconception that they are blue sky growth companies.”