What Dividend Investors Should Know About Technology Stocks

The first quarter’s uptick in interest rates has raised concerns with investors about the potential for headwinds in the stock market if rates continue to increase. As opposed to bonds—and perhaps to the surprise of some—stocks often rise in value when interest rates rise. Dividend growth strategies focused on companies with the longest track records of consistent dividend growth tend to be all-weather strategies that have performed well during a variety of interest rate environments. They may contribute positively to performance through both price appreciation and growing income streams, even when interest rates are rising.

First Quater 2021 Dividend Scorecard

Investors may not immediately associate dividends with technology stocks. As recently as 10 years ago, relatively few technology companies even paid dividends, much less grew them. In fact, only one in four tech stocks paid a dividend in 2011.

The times have changed. According to S&P Dow Jones sector data, by 2020, approximately one-half of all technology stocks now pay a dividend and almost one-third are growing those dividends. The trend toward paying and growing dividends is also meaningful when compared with one of the sector’s consistent storylines—share buybacks. Paying and increasing dividends often indicate management’s confidence in the future trajectory of the business, while share buybacks may be driven by more transitory factors. If tech’s trend toward dividends is any indication, it seems likely that more technology companies will continue to initiate dividends over the coming years. Dividend investors who are not paying attention to the technology landscape may be missing a potential opportunity.

Interest Rates Are Rising and Stocks Are Performing Well

Interest rates have been increasing since the summer of 2020, but the stock market has continued to rise. Some investors have seen this as gravity-defying and perhaps a sign of growing risk. After all, rising interest rates increase the discount rate on future cash flows of a stock, which in turn lowers the present value. Stocks are not bonds, though. A bond paying fixed coupons is defenseless in the face of rising rates—when rates rise, bond prices typically fall. Stocks, however, are different. Earnings grow. So too can dividends. It is the battle between growth and higher discount rates that can muddle the relationship between stocks and rising interest rates.

The history of stock market performance in various interest rate environments is mixed. Standard & Poor’s has found that, prior to 1998 and including the period when interest rates peaked in the early 1980s, stocks performed best when rates fell the most. Over the past two decades, however, rising rates have not necessarily caused the same results. Stocks have performed strongly during several sustained periods when rates increased.

The Takeaway

While the relationship between stock performance and rising interest rates isn’t as cut and dried as some believe it to be, what does seem clear is that rising rates don’t always coincide with poor equity performance. Stocks have performed well in prior periods of rate increases. In fact, an equity strategy focused on dividend growth like the S&P 500 Dividend Aristocrats Index may provide an evergreen approach for almost any interest rate environment. Dividend growth strategies have even outperformed high dividend yield strategies from a return and risk perspective when Treasury yields moved higher.

Dividend growth strategies have also rightly drawn increased interest from income focused investors while bond yields have been in secular decline. Despite recent yield increases, bond yields still have a long way to rise before they are equal to dividend equity yields. And perhaps even more importantly, dividend growth strategies delivered income growth over time, something that fixed income yields did not do.