When it comes to dividend investing, the tech sector often doesn't rank very high. That's a mistake. While technology companies are usually more concerned with innovative growth, and dividend yields are on average far lower than other areas of the market, oft-overlooked tech names that dole out a dividend have some key advantages. Technology can carry some high-profit margins due to a less competitive field (versus the energy or finance sectors). Plus, it's an always evolving growth industry, giving those companies that choose to pay shareholders in cash room to grow those payouts over time. It can be a powerful combination for investors in search of income.
Three tech dividend stocks chosen by Fool.com contributors for the month of August are Taiwan Semiconductor (TSM -0.34%), Cisco Systems (CSCO 0.06%), and Applied Materials (AMAT 1.46%).
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Why have one chip when you can have them all?
Nicholas Rossolillo (Taiwan Semiconductor): Taiwan Semiconductor (TSM) is the world's largest and most advanced contract chip manufacturer. The company handles fabrication for a large and growing list of names. Even chipzilla Intel (INTC 0.64%) implied in its latest quarter it is facing supply-chain issues and production delays and may need to tap TSM for help.
Due to a hardware upgrade cycle, and the new 5G network and AI technologies, TSM has posted an impressive surge of new business so far in 2020. Revenue and net income is up 35% and 86%, respectively, through the first half of the year. Besides a general rally in sales (for a manufacturer, revenue is cyclical and sensitive to supply and demand), the bottom line is getting a huge boost from high-end chipmaking. The company's 7- and 16-nanometer process -- representing the smallest and most advanced chips -- represented 54% of revenue in the last quarter. And the latest 5-nanometer manufacturing process is now headed out of research and development and into monetization phase, with 3-nanometer on schedule to begin production by 2024.
It's a strong tailwind that could boost TSM's results for at least the next few years. Between its stellar results and the possibility of needing to pick up Intel's slack, the stock has surged 42% to date. As a result, shares are priced at a premium 28 times one-year forward expected earnings. However, if dividends are your aim, don't let the price tag scare you away.
This is a highly profitable semiconductor company, churning out operating profit margins of no less than 30% and as much as 40% over the last decade. That gives TSM ample room to innovate as well as steadily increase its dividend, which is currently yielding 1.9% a year. It isn't the most lucrative payout around, but the possibility of higher dividend income over time can be a powerful force to be reckoned with. Put simply, I think this is one of the best ways there is to bet on the semiconductor industry overall and simultaneously get rewarded with cash along the way.
I left my heart in Cisco Systems
Anders Bylund (Cisco Systems): Income investors have many reasons to like networking equipment giant Cisco Systems. The company has been raising its payouts every year since the dividend policy was introduced in 2011. Cisco's share prices tend to rise over time, but the steady payout increases have generally kept the yield near 3%. The company also has plenty of headroom to keep the dividend increases coming; Cisco spent just 40% of its free cash flows on dividend payments over the last year.
Looking ahead, Cisco is poised to benefit from explosive macro trends, such as cloud computing, 5G wireless networks, and next-generation short-range networks under the Wifi 6 banner. The COVID-19 pandemic pumped the brakes on these growth opportunities, but Cisco remains an industry leader in a networking industry with tons of growth potential for the long haul.
Cisco offers investors strong cash generation, steady dividend growth, and a fantastic long-term business plan. All of these shareholder-friendly qualities are on sale right now. Cisco's stock has fallen 16% in the last 52 weeks, and the stubs are trading at just 15 times forward earnings estimates. What's not to love?
This semiconductor equipment leader continues to innovate
Billy Duberstein (Applied Materials): While the Nasdaq Composite has skyrocketed since March, there are still a few leading tech stocks that haven't quite caught up to their February highs yet still look like solid values. The world's largest semiconductor equipment maker by revenue, Applied Materials is one of them.
Applied Materials makes the machines that enable both logic and foundry and memory customers to produce ever smaller yet more powerful advanced semiconductors. This is a great industry to be in because, as these delicate manufacturing processes become more and more difficult, the capital intensity of chip manufacturing goes up, requiring manufacturers to buy more machines and services from companies like Applied.
Second, much of this technologically sophisticated industry has consolidated around just a few large players, and each of the industry leaders has very high-profit margins and returns on capital. That enables each to pay steady, rising dividends while also buying back stock. Applied Materials' dividend yield stands at just 1.4% today, but its payout ratio is just 26.5%, meaning its dividend payout is covered almost four times over by its trailing net income.
Even better, that net income could grow a lot in 2021. After 2019 saw semicap equipment spending fall 8% due to the U.S.-China trade war, research firm SEMI now projects a 4% drop in 2020 equipment spending due to supply delays caused by the COVID-19 pandemic, but a massive 24% rebound in wafer-fabrication equipment spending in 2021, reaching what should be record levels.
With modern applications like 5G phones and artificial intelligence needing more advanced chips, there's only so long that manufacturers can hold off on these investments in their technology road maps before buying more of Applied Materials' machines. Applied is also continuing to innovate, as it just unveiled its new Selective Tungsten technology, which allows chips to use less connective material in between transistors, eliminating a big bottleneck in chip performance and power efficiency.
At just 20 times trailing earnings and 15 times next year's earnings estimates, Applied Materials is one of the best combinations of quality and value in tech today, with room to grow its dividend over the next decade.
