While the 5%-plus yield on short-term Treasury bonds looks quite tempting today, don't count on seeing that last. As inflation eventually falls back toward the Federal Reserve's 2% target, the yield on "risk-free" bonds will go down, too.
However, tech-enabled growth stocks have the potential to pay you a dividend that rises each and every year, provided that company's earnings per share grows, too.
Looking beyond the short term, that's much more attractive. And it's why investors should use the recent pullback in technology stocks to scoop up these long-term winners.
Taiwan Semiconductor Manufacturing
The world's largest foundry, Taiwan Semiconductor Manufacturing (TSM 3.69%), boasts a strong technology lead in complex chipmaking. In fact, every artificial intelligence chip today will probably go through TSMC's foundries.
Yet despite that strong position and a big beat on revenue and earnings in the first quarter, TSMC's stock pulled back and now sits roughly 20% below its recent highs. That's probably because TSMC actually lowered its full-year 2024 forecast for semiconductor industry growth, from over 10% to just around 10%.
But the reaction to this seems far overdone. First, the lowering of prior guidance had almost entirely to do with one subsegment of the market: the automotive chip market. That market was strong following the pandemic all the way through 2023, but it's now experiencing the downturn the PC, smartphone, and data center markets experienced in the 2022-2023 period.
Outside of that, things seem fine. In fact, because of its leading position, TSMC reaffirmed its own growth target for the year, in the low- to mid-20% range. TSMC's outsize growth is powered by the artificial intelligence chip market, which TSMC expects to grow at a stunning 50% compound annual growth rate for the next five years, increasing from a single-digit proportion of TSMC's revenue today to over 20% by 2028. So while the commentary may have been a negative for some other chipmakers, there wasn't much reason for TSMC to sell off.
Meanwhile, the company is now moderating its capital spending after outsize investment over the past few years. Despite this year's 20%-plus revenue growth projection, TSMC anticipates spending only roughly what it spent last year on capital equipment.
That's causing free cash flow to gush to about $8 billion in the first quarter, far outpacing the company's $2.5 billion in dividend payments. But given that the company eventually expects to pay out 70% of free cash flow as dividends, that leaves lots and lots of room for TSMC to raise its current 1.6% payout.
Tencent
Some have sworn off investing in China, and that's understandable. U.S.-China relations have soured, dampening trade, and the government's heavy-handed approach over the past few years has caused Chinese tech companies to see lower growth and forced divestitures.
Yet Tencent (TCEHY -0.49%), arguably the highest-quality and most defensive tech giant in China, just increased its dividend by 42%. The company also plans to more than double its share repurchases in the coming year as well.
Chalk this performance up to technology companies that are cutting costs and getting used to a slower but perhaps steadier growth, while focusing on rewarding shareholders with cash profit instead of reinvesting in growth at all costs.
Image source: Getty Images.
Despite a recessionary backdrop, Tencent still managed to grow revenue 7% last quarter, which certainly isn't terrible. Moreover, the company's cost-cutting-measures and focus on bottom-line profitability enabled gross profit to surge 25% and adjusted (non-International Financial Reporting Standards) operating profits to grow an even more impressive 44%.
Those results aren't too shabby for a large company operating in a Chinese economy that's practically in recession. And it's really not bad for a company trading at just 16.5 times earnings. Furthermore, if one subtracts out Tencent's investments in other companies, which total approximately $125 billion, that P/E ratio falls to a dirt cheap 10.8.
Tencent's current dividend yield is only 1.1% after the 42% increase. But with an empire spanning mobile games, social media, electronic payments, and cloud software, expect that yield to expand handsomely as Tencent grows earnings and lowers its share count over time.
Microchip Technology
As TSMC noted in its conference call, the auto and industrial chip sector is in a downturn right now. That affects Microchip Technology (MCHP 1.92%), a leader in microcontrollers and analog chips, which gets 41% of its revenue from industrial customers and another 17% from autos.
But investors may want to use this downturn to take a position in this long-term winner. Microchip has a 30-year history of profit growth, growing operating profit at a 15.5% average rate over the course of 30 years. And Microchip was still able to make a 41.2% operating margin last quarter in spite of a big downturn in revenue. So Microchip appears to be a competitively advantaged winner going through a short-term downcycle. Still, auto and industrial chips should grow over the long-term, as industrial equipment and cars and trucks become smarter and more electrified.
Meanwhile, after making a huge acquisition in 2018, Microchip has spent most of the past six years paying down $7.1 billion of acquisition debt. As Microchip's debt load has fallen, the company has been increasing the proportion of free cash flow going to dividends and repurchases. Last quarter, the company devoted 82.5% of free cash flow to shareholder returns, raising the company's dividend by 25.7% over the prior-year quarter. Management targets increasing shareholder payouts as a percentage of free cash flow by five percentage points every quarter.
So while Microchip's dividend yield is just 2.1% today, look for that to grow as the company eventually devotes 100% of free cash flow to shareholders by next year and the company grows earnings over the long term.
