Increasing dividend potential for tech stocks

Technology stocks are not what they were ten years ago, say investment specialists, with strong balance sheets and good cash flow, as well as growth potential.

Stuart O'Gorman, co-fund manager of the Henderson Global Technology Fund and New Star Technology Unit Trust, points out that US technology companies have very low levels of debt, and because they are relatively young do not have large liabilities like a number of old economy stocks. They also continue to be cash generative which could mean dividend rises in the sector, as the culture of paying dividends becomes more common among them.

Dividend payers include Microsoft, Oracle, IBM and Intel.

Walter Price, fund manager of the RCM Technology Trust, noted that the sector average yield is 2 per cent whereas once it was practically zero. He said: "The business model for the larger companies is increasingly total return so they pay dividends. I think these should be stable and grow because of the way their business is changing to recurring revenue."

Recurring revenue and maintenance is becoming a higher percentage of technology company profits so they do not just rely on selling new products.

Price went on: "Because of this transition you have attractive business models with recurring revenue and high cash streams enabling share buy backs. This gives more stability to stock prices, and paying dividends also reduces volatility."

But growth is still important. Price said: "Technology firms are becoming more heterogeneous with mid caps still exhibiting high growth. This means the sector increasingly has something to offer value as well as growth investors."

But he added that mid cap stocks may also start to pay dividends when they have more than a few billion dollars cash on their balance sheets. He said: "With valuations at between 10x and 20x and free cash flow, companies can pay out a portion of their earnings and yield 2 to 5 per cent, and still have enough for share buy backs and acquisitions."

Price favours mid caps because the larger software companies will not see much growth going forward, for example, SAP, Oracle, Microsoft and Intel are experiencing slow growth, while IBM has hardly grown over the last five years. However, these companies also have positive cash flows on their balance sheets and can grow their earnings.

Asian technology stocks, meanwhile, as well as offering higher growth prospects than their US counterparts, are also leading them when it comes to paying dividends, in particular Taiwan Semi Conductor, which has paid large dividends.

But technology investment trusts still do not offer much in the way of yields. According to WINS data as of 4 August, RCM Technology Trust and Polar Capital Technology Trust offer net yields of 0 per cent, while Herald Investment Trust offers 0.6 per cent.

The average net yield on a global growth trust, by contrast, is 2.9 per cent, US general trusts offer 1.7 per cent and UK growth offers 3.6 per cent.