The technology sector is a surprising source of dividends. This wasn't always the case. Just a few years ago, most technology companies were reluctant to pay dividends at all, preferring instead to use all their cash flow to reinvest in their businesses. After all, in technology, you either innovate or risk falling behind.
But all that's changed. Technology large caps are so large that they generate more than enough free cash flow to reinvest in growth, as well as distribute a portion to investors.
Let's size up two of the biggest dividend payers in the tech sector, Microsoft (MSFT +1.69%) and Intel (INTC 3.00%), to see which might be the better pick for income investors.
Breaking the chains of the PC
Both Microsoft and Intel generate strong free cash flow, but not all is well. They're each in the process of breaking away from the personal computer into new areas to ensure future growth. This makes sense, of course, since global PC shipment numbers imply that the new technological age will be one dominated by smartphones and tablets.
Microsoft's revenue and diluted earnings per share grew 11.5% and 2%, respectively, for the full FY 2014 year, which ended June 30. Profits were weighed down by some non-cash items, so its free cash flow still looks good. Microsoft generated $26.7 billion in free cash flow in fiscal 2014, up nearly 9% from the prior year.
Microsoft is still generating so much cash, even though so many were negative about the company's prospects, because it has made huge gains in the cloud. Microsoft's commercial cloud revenue doubled last year, to $4.4 billion. Specifically, its Office 365 and Azure cloud offerings doubled revenue during the year. Microsoft paid slightly more than $8.8 billion in dividends last year, meaning its free cash flow payout ratio is just 33%.
Microsoft distributes only one-third of its free cash flow to investors as a dividend. This is why the company can afford to increase its dividend at such high rates. It's upped its dividend by an average of 16.5% compounded annually over the past five years.
Intel is halfway through its fiscal year. Sales and earnings per share increased 8% and 40%, respectively, last quarter. In the first six months of the year, free cash flow totaled $3.4 billion, which is down 16% versus the same six months last year. Intel has struggled more than Microsoft in breaking the chains of the personal computer. Its PC division still represents more than 60% of its total revenue.
However, there's hope for Intel's future. It's making huge progress in an exciting new area called the Internet of Things, in which virtually every consumer device can be connected by the cloud and communicate data with each other. Intel's Internet of Things business posted 27% revenue growth over the first half of the year.
But Intel still comfortably covers its dividend payments with free cash flow. Intel's free cash flow payout ratio stands at 65% over the first half of the year. Since Intel distributes less than two-thirds of its free cash flow to investors, there's still enough cash to keep investing in the business.
The better dividend: Microsoft
Intel and Microsoft are both highly profitable companies that have a track record of dividend growth. But Microsoft has outpaced Intel in recent years in breaking away from the personal computer and expanding into new areas. Intel has been a little slower to adapt, which is why it hasn't been able to raise its dividend in more than two years.
Microsoft, on the other hand, keeps increasing its dividend at healthy rates. Even better, it's been a full year since Microsoft last raised its dividend, meaning investors should fully expect another dividend increase in the very near future.
Intel and Microsoft both yield around 2.5%, but Microsoft's better free cash flow metrics and dividend growth prospects make it the winner in this dividend matchup.
