March 14, 2003 — Microsoft startled market analysts when it announced in January that it would start paying a dividend to its investors in the first quarter, relinquishing at least some of the tens of billions of dollars of cash on the company’s books.
Now the question investors are asking their advisors is how many technology companies — historically reluctant to pay out dividends — might follow suit, and how they can profit from any trend that might take shape. The trick may be to identify those companies that are best positioned to pay dividends, and then the funds that have significant stakes in these enterprises, analysts agree.
The most likely candidates are technology companies whose businesses are profitable, generate consistently strong cash flows, have large cash balances, and whose businesses aren’t cyclical and don’t need that cash to finance capital projects. Those least likely to start issuing dividends still view themselves as high-growth companies.
“Executives will be cautious about signaling to the market that their growth rate is slowing, which is what a dividend is usually seen as doing,” says David Readerman, growth stock strategist at Thomas Weisel Partners, a San Francisco-based investment bank.
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Software companies are likely to be among the biggest dividend-payers going forward, says Brooke Dane, a member of the technology stock research team at Putnam Investment Management. These companies typically generate large amounts of cash, but their businesses are maturing, and they face a slower rate of growth in the core businesses. Microsoft is by far the best example of this, with more than $40 billion in its war chest. Traders refer to its new dividend policy as a fraction of what the company should be paying out, and Readerman, for one, says if the company were serious about dividends, it would be paying five times as much, or about 72 cents a share annually.
Software companies as diverse as BMC Software (BMC), CheckPoint Software (CHKP), Oracle (ORCL) and Siebel Systems (SEBL) may begin paying dividends in the not-too-distant future, analysts say. A number of large technology funds maintain substantial positions in Oracle, which has a $5.5 billion pool of cash from which dividends could be paid. These funds include MFS Technology Fund/A (MTCAX) with a 5.55% interest, and Firsthand Funds:Technology Leaders Fund (TLFQX) with 5.14% of its assets in Oracle. A handful of software firms, like Veritas (VRTS), which has $2.2 billion in cash on hand, has indicated it won’t start paying dividends.
The best strategy may be to identify funds that have stakes in a number of these companies. For instance, the AXP Global Technology Fund/A (AXIAX) has large positions in Microsoft, Oracle and Cisco Systems. The Hartford Global Technology Fund/A (HGTAX) also has stakes in Microsoft, Intel (INTC) (which already pays a small dividend), and Cisco Systems (CSCO), whose shareholders previously rejected a dividend, but whose top executives are now reconsidering their opposition to dividend payments. The IDEX Great Companies-Technology/A (IGTAX) has substantial positions in many current and potential dividend-paying technology companies, including a 6.65% stake in Dell Computer Corp. (DELL). At last report, more than 35% of its holdings were in large, cash-rich companies that are considering dividend payments, or already pay at least a small dividend. MFS Technology Fund has about 32% of its assets in a similar group of companies.
Though President Bush’s economic stimulus plan is seen in jeopardy, if passed by Congress, the nature of these funds could well undergo a fundamental change, should dividend payments to investors become free of income taxes. Until now, analysts and investment advisers have been accustomed to regarding technology funds as a source of capital gains — or capital losses — rather than a source of dividend income. That’s due to the fact that, of the 75 technology companies in the Standard & Poor’s 500-stock index, only 17 pay dividends. While the average yield as on the 358 companies in the S&P 500 index that do pay dividends is 2.70%, and the average yield for the index as a whole is 1.91%, the yield generated by these technology stocks is a mere 1.01%.*
But capital gains are scarce these days, and even if the economy rebounds, they may not be as easy to find in the future. That means that a growing number of large institutional investors are pressing companies like Dell, Cisco and Oracle to implement dividends.