Why These Companies Need Higher Dividends

In a healthy economy, investors rush to put their money into companies that will take decisive action to produce profits. Now that the economy has remained sluggish, however, investors want that money back in their own pockets to invest themselves -- and companies that won't deliver are getting taken out to the woodshed.

Cheap tech?
An article in Barron's over the weekend highlighted an interesting phenomenon among tech stocks. It noted that the tech sector was at its most undervalued level in nearly 20 years. As one possible explanation, the article suggested that most tech companies are cash-rich and have turned off investors by largely refusing to pay significant dividends -- or any dividends at all, in many cases.

It's true that by historical standards, many of the biggest tech stocks look cheap on an earnings-multiple basis. Here are some of the businesses with big cash balances on their hands:

Source: Yahoo! Finance.

In fact, one analyst goes further, arguing that big tech companies with more cash than good ideas are in fact hurting shareholders by recklessly spending their money on overpriced acquisitions. There's certainly plenty of ammunition on that score lately, both inside and outside the tech sector:

• Why, for instance, was 3PAR (NYSE: PAR) worth $33 to HP, when the market valued it at $8 as recently as early last month? Dell may feel like the loser in the bidding war, but shareholders should be happy they didn't end up squandering any of its $12.4 billion in cash on a top-dollar deal.
• Rental car also-ran Dollar Thrifty Group (NYSE: DTG) has topped the charts since the stock market's March 2009 lows, rising from less than $1 to $30 in a single year. Yet that didn't stop Hertz (NYSE: HTZ) and Avis Budget Group (NYSE: CAR) from making offers as high as $50 to buy out their competitor. The latest bid from Hertz, trumping Avis's $47 offer, includes a huge cash component of $43.60 per share, for which it will likely need to get financing.

Obviously, dividend-paying companies can also make high-priced deals that turn out to be big mistakes. But when a company already has a commitment to part with a decent chunk of its cash flow, it at least has to consider more closely what a multibillion-dollar flyer on a chancy acquisition would do to its ability to continue making dividend payments.

More importantly, if cash-rich companies can find no better use for their money than to bid acquisition targets into the stratosphere, then it's no wonder that shareholders want that money back. And if investors can't get those companies to start coughing up the cash, they'll vote with their feet.

An opportunity in the making?
That, in turn, grabs the attention of value investors, as valuations fall to levels rarely seen for their stocks. The vital question, though, is whether these companies are destroying shareholder value by making ill-advised purchases with their cash. Given the egos involved among upper management in the tech sector, you have to be constantly vigilant to ensure that your company doesn't end up making a costly M&A mistake.

If these companies see the light and join the ranks of higher-paying dividend stocks, however, then shareholders who stick it out could get a double windfall as a reward. Not only would they get more cash, but investors who are hungry for yield could also flood into the stocks, driving up prices and reversing a disturbing trend within the sector.

In the end, it all comes down to whether the investments companies have access to are good prospects for shareholders. If you can find a better investment on your own, then demanding a dividend really makes the most sense.

It's a dangerous market, and Rick Munarriz has found three sectors you really need to avoid right now.