The Best Technology Dividend Stocks

Dividend stocks are back in vogue. Their high-growth brethren got a lot of the attention over the past 20 years, but now the tables have been turned. A decade that's brought us two major recessions and eliminated untold billions in wealth has led us here -- as well it should. The reinvestment of dividends, over decades, will help any investor handily beat the broader market.

Today, I'm going to dive into some popular technology stocks that are offering sizable dividends to see whether any of them are worth your money.

How sustainable are my dividends?
If you're buying a stock for its dividend, you want to be sure the stock will be around for years to come. Start by looking at the payout ratio, which tells you what portion of earnings a company uses to pay for its dividends. In their book Million Dollar Portfolio, David and Tom Gardner suggest that you should hold only stocks with a payout ratio of less than 65%.

Company

Dividend Yield

Payout Ratio

Himax Technologies (Nasdaq: HIMX  )

5.5%*

81%*

Intel (Nasdaq: INTC  )

3.40%

30%

Applied Materials (Nasdaq: AMAT  )

2.60%

24%

Garmin (Nasdaq: GRMN  )

6.0%

61%**

Taiwan Semiconductor (NYSE: TSM  )

3.20%

44%***

Microchip Tech (Nasdaq: MCHP  )

3.80%

64%

Source: Yahoo! Finance.
*Calculated based on Himax's next dividend-payable date of July 20, when it will pay $0.12 per share.
**Based on recently declared $2-per-share dividend through March 30, 2012.
***Payout ratio based on last quarter's profit per ADR.

Himax's past dividend rates proved too high, and the company recently ratcheted its dividend back from $0.25 per share to a more reasonable $0.12. But even now, the company has a payout ratio above the 65% level we're looking for. All other companies on the list, however, pass our test.

Where dividends are really paid from
This is where things get tricky. Because earnings are reported using the accrual method, companies may not yet have collected all of the money that they say they've earned. Things like accounts receivable and payable, depreciation, and goodwill are included in earnings -- and they don't immediately affect the amount of money a company has in the bank.

The good news is that there is a way to see how much money a company has put in the bank: free cash flow. This number is very important -- some Fools would say more important -- in evaluating a company's dividend sustainability. Ultimately, dividends are paid from free cash flow, not from earnings.

Check out the free cash flow payout ratio for the companies that are left from our first list.

Company

FCF Payout Ratio

Intel

39%

Applied Materials

24%

Garmin

52%

Taiwan Semiconductor

149%

Microchip Tech

57%

Source: Yahoo! Finance.

Taiwan Semiconductor gets tossed out here. And further investigation shows that Garmin's dividends tend to be scattered and lumpy -- two characteristics that income investors probably aren't crazy about. So Garmin is gone, too.

Dividend growth
Although dividend yields are important, long-term, buy-and-hold investors should also keep an eye on dividend growth. When a company consistently raises its dividends, you can supercharge your returns.

Company

3-Year Compound Annual Growth Rate

Intel

11.27%

Applied Materials

6.72%

Microchip Tech

3.22%

Source: Dividendinvestor.com.

Over the past five years, Intel has consistently raised its dividends at attractive rates. And we know, since Intel passed our first two tests, that its dividend is easily sustainable as well. And even though Applied Materials and Microchip Tech don't have the same impressive growth rates as Intel, they're still worth looking into.

Capital gains
Finally, when you invest in dividend stocks, it's not enough to simply evaluate the health of the dividend. The opportunity for capital appreciation (i.e., a rise in the stock price) is equally important. One metric analysts use to measure whether a stock is over- or undervalued is the PEG (price/earnings-to-growth) ratio. In theory, when the ratio is at 1, the stock is fairly priced. Anything below 1, and you're getting a deal; anything above 1, and you may be overpaying. Here's how our final three stocks break down.

Company

PEG Ratio

Intel

0.8

Applied Materials

0.88

Microchip Tech

1.13

Source: Yahoo! Finance.

Foolish takeaway
As you can probably guess, I'm a big fan of Intel. The company has a sustainable, high payout that's growing, and it appears to be priced under its fair value. That's why I own the stock. At the same time, Applied Materials and Microchip Tech are worthy of investigation as well. I encourage you to add them to your watchlist below.

If you're looking for more dividend ideas, consider 13 names from a free report from The Motley Fool's expert analysts called "13 High-Yielding Stocks to Buy Today," including one that a senior retail analyst calls "the dividend play of a lifetime." Tens of thousands have requested access to this report, and today I invite you to download it at no cost to you. Get instant access to the names of these 13 high yielders. It's free!

Fool contributor Brian Stoffel owns shares of Intel. The Motley Fool owns shares of Applied Materials and Intel and has bought calls on Intel. Motley Fool newsletter services have recommended buying shares of Intel and creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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