Why Income Investors Should Look at Large Cap Tech for Dividends

It's true that high-yielding sectors like utilities provide great yields now. But, what those companies often lack is the ability to grow their payouts rapidly over time. Technology companies have no such problem because behemoths like Microsoft (MSFT -2.45%), Apple (AAPL 0.52%), and Cisco Systems (CSCO -0.52%) generate a lot of free cash flow, with little debt to service.

And, each company is making investments in their respective areas of technology that should pave the way for strong dividend growth in the future.

The end result is that these companies have a lot of cash at their disposal, and they're slowly, but surely, embracing the merits of giving investors their fair share. That's why, investors looking for both solid current yields and outsized dividend growth, should look no further than technology.

A trio of big dividend payers
A few years ago, technology companies were extremely reluctant to pay dividends. The rationale was that, because technology was such a cyclical industry, tech companies had to retain as much as possible to reinvest in innovation and research and development.

The reality, though, is that huge technology companies such as Microsoft, Apple, and Cisco generate more than enough cash to accomplish their goals and still reward shareholders. Each of these three companies are megacaps with huge cash flow, and since they have little to no debt, they can easily afford to reinvest responsibly and send a portion of profits back to shareholders.

To illustrate, here are some key metrics that show just how strong their businesses are:

Source: Microsoft Q3 Report, Apple Q2 Report, and Cisco Q3 Report; Statement of Cash Flows

As you can see, each of these three titans of technology generates more than enough free cash flow to support their solid current dividend yields, as well as grow their distributions over time and cover their debt obligations.

Cisco has taken the greatest strides since instituting its dividend in 2011. Since initially offering a token payout, it has more than tripled its dividend in that time. That has brought it on par with its peers in the technology space.

It was a smart move for each of these three companies to take dividends more seriously. Their immense cash hoards had begun to burn a hole in their pockets. Rather than let tens of billions of dollars sit on their balance sheets, earning virtually nothing for shareholders, it makes perfect financial sense to distribute some of that cash to shareholders at a higher rate of return.

Plus, in each case, investors should have plenty of confidence in these companies generating more than enough cash flow to support future dividend increases.

Microsoft is performing very well, specifically in its cloud-based services. To that end, Office 365 revenue more than doubled last quarter. Revenue from Azure soared more than 150%, which makes it clear that Microsoft's cloud platform is very attractive to developers.

Apple, of course, has some major product releases on the horizon. These include the iPhone 6, a smart watch, or an Apple television, which will all help boost free cash flow.

Meanwhile, Cisco is focusing on the emerging markets, where it's struggled recently. But Chief Executive Officer John Chambers reiterated his commitment to under-developed economies, where orders declined 7% last quarter. Assuming any progress on this, Cisco likely has better days ahead given the potential of emerging markets.

The Foolish bottom line
These payouts, which are each at or near 3%, are extremely valuable in climates like the one in which are currently. With interest rates near historic lows, investors don't have many opportunities to earn satisfactory yields from bonds. To that end, the yield on the 10-Year U.S. Treasury Bond sits at just 2.5%, which is lower than these three companies' respective dividend yields.

Of course, the added bonus for investing in these dividend stocks is that your income will rise over time. Investors won't have to be content with the static yield of a 10-year bond. Because Microsoft, Apple, and Cisco raise their dividends over time, shareholders' purchasing power will strengthen, not weaken like it would with a fixed-income security.

While it may be a surprise, the technology sector is now a great source of yield and dividend growth. For die-hard income investors, take a closer look at Microsoft, Apple, and Cisco.