Get Your Dividends From ... Tech?

After a terrible 2007 and an uncertain year ahead for financial stocks, investors looking for stable dividend payers need to dig a bit deeper for new ideas these days.

Tech stocks (yes, those tech stocks) might be one place to start. Tack it up to the improved tax treatment of dividends or the maturation of big tech, but tech stocks deserve a look from dividend-minded investors.

Here's why
In a recent interview with Fortune, Susan Byrne, the founder, chairman, and chief investment officer of Westwood Holdings Group, said tech stocks "always had great balance sheets, and they generate tons of cash. Now they're paying dividends, they have very low payout ratios on their free cash flow, and they're starting to grow."

The high growth potential of tech stocks in combination with low payout ratios mean these firms generate enough cash to continue dividend payments while reinvesting in their businesses.

Examples include:

Company

Payout Ratio on Free Cash Flow (LTM)

IBM (NYSE:IBM)

17%

Microsoft (NASDAQ:MSFT)

22%

Intel (NASDAQ:INTC)

35%

Source: Capital IQ.

But hurdles abound
Two obstacles investors currently face with tech dividend-payers are:

  • Short track records. While some blue chips like General Electric (NYSE: GE  ) have paid an uninterrupted dividend for more than 100 years, the "new" tech dividend-payers like Microsoft and Qualcomm (Nasdaq: QCOM  ) have only paid regular dividends since 2003. Without a long track record to analyze, it is unclear how the tech payers will handle their dividend policies if the 2003 Bush tax cuts are allowed to expire in 2010.
  • Low yields. Investors looking to boost their income with high-yielding stocks may not find many attractive opportunities in tech. For example, Garmin (Nasdaq: GRMN  ) only yields 1.1% and Hewlett-Packard (NYSE: HPQ  ) doles out just 0.7%. In fact, only two stocks in the Nasdaq 100 have a yield of more than 3%.

So what?
It's encouraging that select tech stocks are paying dividends, but they might not be screaming buys for the long run. One reason: They don't pay enough.

For instance, a 2006 Credit Suisse study by Pankaj Patel, Souheang Yao, and Heath Barefoot found that "companies with high dividend yields and low payout ratios have the best returns" -- at least over the period they studied, 1990 to 2006. So while the low payout ratios of the tech stocks in the aforementioned table are a positive sign, they don't pay enough to fall into the high-yield, low-payout category.

Get on board
Our Motley Fool Income Investor service scours the investing universe to find stocks that offer the killer combination of growth and income -- generally, stocks that yield more than 3% and have low payout ratios. To illustrate, back in September, Income Investor co-advisor James Early recommended Brazilian oil conglomerate Petrobras to subscribers. At the time, Petrobras yielded 3.5% and paid out just 37% of its earnings to shareholders. Since then, Petrobras has doubled in value on the back of higher oil prices and a recent discovery of up to 8 billion barrels of oil in the Santos region of Brazil (though that probably had nothing to do with its payout ratio).

On average, Income Investor picks are outpacing the S&P 500 by more than five percentage points. If you'd like to learn more about those recommended stocks, a full-access 30-day trial is yours. Take advantage of the offer by clicking here.

Fool contributor Todd Wenning will argue that Friday Night Lights on NBC is the best network TV program this decade. He does not own shares of any company mentioned. Microsoft and Intel are Motley Fool Inside Value picks. Garmin is a Stock Advisor choice. The Fool's disclosure policy is too legit to quit.


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