Historically, the technology sector hasn't been one for paying out huge dividends. Because many of these companies are small and growing, they reinvest their money into their own operations to fund future growth.
Alas, the day will soon be coming when some tech stalwarts will start paying nice dividends. Though these mature companies will likely leave their rule-breaking, 100%-share-appreciation days behind, a future filled with dividends isn't that bad either.
For those who scoff at the power of dividends, you need only read Jeremy Siegel's The Future for Investors. In it, he writes: "Dividends matter a lot. Reinvesting dividends is the critical factor giving the edge to most winning stocks in the long run."
So today, I'm looking at who is offering dividends right now in the tech sector, with the belief that these companies will be the ones consistently offering (and hopefully raising) dividends in the future.
An important metric for dividends
One of the most popular metrics used to measure a dividend's sustainability is the earnings payout ratio. In essence, this measures how much of a company's earnings are used up in paying out dividends. As the theory goes, the lower the payout ratio, the more sustainable the dividend.
Take a look at the table below. It includes seven popular technology stocks and their payout ratios.
Earnings Payout Ratio
Source: Yahoo! Finance.
In their book Million Dollar Portfolio, David and Tom Gardner suggest that you should only hold stocks that have a payout ratio of less than 65%. None of these stocks are in danger of paying out too much from earnings.
But wait, there's more!
This is where things get tricky. Because earnings are reported using the accrual method, all of the money that a company says it's earned hasn't necessarily been paid to it yet. 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 in fact a way to check how much money a company has put in the bank: free cash flow. This number is very (some Fools say more) important in evaluating a company's dividend sustainability. In the end, dividends are paid from free cash flow, not from earnings.
Check out the free cash flow payout ratio for these companies.
FCF Payout Ratio
Source: Yahoo! Finance. TTM dividends used when possible, otherwise future dividend payouts were used.
Though some numbers changed marginally, this shows that these tech dividends are clearly healthy.
The flip side of this, of course, is that the dividend yields for these companies are relatively low. Again, this is largely because the technology sector is still in the early stages of paying out dividends.
The good news is that this means there's a long runway for dividend growth in the future. When companies like Broadcom, Cisco, and Corning are paying out dividends that account for less than 15% of free cash flow, it tells you they will be able to raise those dividends considerably when the time comes.
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