Intel (NASDAQ:INTC) has had a great run in 2014. Its stock price is up 28% year to date, which handily outpaces the 10% spike from the S&P 500. Growth investors hoping for capital gains have clearly been rewarded from owning Intel. However, investors who hold Intel stock for the income-generating dividend payments might feel shortchanged by the company's payout policy.
Intel's dividend growth has not kept up with its impressive capital gains. The chipmaker's stock pays a 2.7% dividend yield based on its current stock price, which is a nice payout. But it hasn't increased its dividend since 2012. It is falling behind other companies in the technology sector that raise their dividends every year.
Intel has more than enough financial flexibility to pay the dividend. The company generates significant cash flow, and it's not in any danger of harming its ability to grow the business by raising the payout. Here's why Intel can, and should, increase its dividend.
How Intel is rewarding growth investors at the expense of dividend investors
Intel generated $6.6 billion in free cash flow over the first nine months of the year. Its dividend cost $3.3 billion in this time period. That means Intel's current dividend accounted for only about half of its free cash flow. That is not a concerning ratio by any means -- even if it had no free cash flow growth, the company has plenty of room to boost its dividend.
Moreover, even if Intel did not want to boost the payout ratio beyond 50% of free cash flow, the company could raise the necessary cash to increase its dividend. One way would involve reducing the amount of cash Intel spends on share buybacks. Intel currently uses a sizable majority of its free cash flow to buy back its stock. Over the first three quarters of the year, Intel spent $7.1 billion on share buybacks, which exceeded the company's free cash flow. This is draining Intel's cash balance.
Intel could reduce its share buyback program by $1 billion, and use half of that for a $0.10-per-share dividend increase, based on the company's 5 billion shares outstanding. That would represent a solid 11% dividend raise, and would keep investors who own Intel for the payout happy.
Plus, Intel could retain the remaining $500 million to improve its balance sheet. Aggressive share buybacks have contributed to a 43% year-to-date reduction in cash and short-term investments on its balance sheet, from $11.6 billion to $6.6 billion.
One argument for stock buybacks is that they help increase the company's stock price, which is true. Intel's share repurchases have assisted its impressive rally this year. Going forward, however, share buybacks will be less accretive now that the stock price has soared. Each dollar will buy fewer shares when the stock price is up.
Intel should raise its dividend
There are definitely circumstances in which a company will understandably resist increasing its payout. If the business was deteriorating, or the company was already distributing too high a percentage of its earnings, I'd give Intel a pass. But that's clearly not happening here. In this case, Intel generates more than enough cash flow to justify a dividend increase. Intel's dividend hasn't been raised in more than two years. Meanwhile, semiconductor peers Qualcomm and Texas Instruments both aggressively raise their own dividends every year.
Intel's free cash flow and strong balance sheet leave plenty of room for a dividend increase. And, in case Intel is still reluctant, it could always shift the balance between its share buyback program and dividend policy. Intel's stock repurchases account for approximately 68% of its total capital allocation to shareholders. Even a slight reduction in that line item could produce enough funds to provide a solid dividend increase. It's important to keep income shareholders happy.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.