What Dividend Investors Should Know About Technology Stocks

The Two Sides of Technology Investing

Technology stocks have long been viewed as an exciting sector to invest in for growth, and, more specifically, innovation and invention. And while there will always be companies in the sector that are in high-growth mode, the sector as a whole has grown up from the long-ago days of the dot-com bubble. Growth and technology will always be synonymous for some investors, but the sector has evolved into having essentially two types of companies in it: early stage and well established.

Early-stage technology companies tend to be characterized by high growth rates, little-to-no profitability, and higher-than than-average volatility. This can be contrasted with well-established technology names with demonstrated staying power, healthy margins and plenty of free cash flows. Importantly, focusing on more mature tech companies doesn't mean sacrificing growth—these names still have long runways of attractive growth rates ahead of them. The upshot for income investors is that many of these well-established technology businesses are delivering yield to shareholders via dividends.

Technology Stocks Today—An Unexpected Source for Dividends

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.

Nearly Half of Technology Companies Now Pay Dividend

In a yield-starved market, publicly traded (listed) infrastructure owners and operators have provided an attractive income stream, supported by stable cash flows. Many investors could be well served to focus on the income-generating infrastructure assets that may be strengthened by government action and a successful vaccine rollout.

Record-low interest rates have created challenges for income-seeking investors. Traditional sources of yield, like fixed income investments, can nowadays be inadequate with current 10-year Treasury rates hovering well below 2%. Investors have therefore looked to alternative sources of yield, like high dividend-yielding equities, to enhance their portfolios’ income generation capabilities.

However, risks abound. Typically, stretching for yield can lead to poor outcomes if investors focus on stocks that may not be able to sustain their dividends in times of economic hardship. When stocks cut their dividends, poor performance often follows, as was the case during 2020. In contrast, pure-play infrastructure stocks—companies whose business is primarily owning or operating infrastructure assets like toll roads, electricity-transmission networks, airports and water supply systems—have typically generated long-term cash flows, regardless of the economic environment, and may be a compelling source of yield for investors, although it should be noted that there is no guarantee of income.

Introducing the S&P Technology Dividend Aristocrats

Recognizing the emergence of technology stocks as a prominent source for dividend growth, Standard and Poor’s introduced the S&P® Technology Dividend Aristocrats® Index in 2019. The index tracks the performance of technology and technology-related companies with a history of increasing dividends for at least seven consecutive years. The S&P Technology Dividend Aristocrats Index uses an equal-weighting methodology, which prevents concentration risk that can be caused by larger names in market-cap weighted indexes. We’ll talk more about this important distinction later.

Technology stocks are now fertile hunting ground for dividends, and, more specifically, for dividend growth, for three primary reasons:

1. The technology sector has become a critical source for the market’s dividends.
   1. As of June 2021, tech stocks contributed approximately 16% of the S&P 1500’s dividends—the second largest contribution of any sector.
2. According to S&P Dow Jones Indices data, through the end of 2020, the technology sector has been growing its dividends at the fastest rate of any sector.
   1. Since 2011, the tech sector has quadrupled its dividend payout, and has grown dividends at a compound annual growth rate of over 16%, far exceeding other S&P 1500 sectors and the broad market in general.
3. Many well established tech and tech-related companies, like those in the S&P Technology Dividend Aristocrats Index, have grown their dividends for a minimum of seven years and have had hallmarks of quality such as stable earnings, solid fundamentals, and often strong histories of profit and growth.
   1. According to FactSet, as of the beginning of 2021, the companies of the the S&P Technology Dividend Aristocrats Index have produced higher returns on equity and had lower debt than the S&P 500.