Investors looking for income from their stocks should give serious consideration to the technology sector. That might be a surprise, given technology companies were long reluctant to pay dividends. The rationale was that since technology is such a quickly evolving industry, companies needed to retain all their cash flow to reinvest in research and development.
But things seem to have changed, and all the better for income investors. Technology companies have grown so large that some of them operate well-established businesses that generate more than enough cash flow to fuel innovation and reward shareholders. Two companies, Intel (NASDAQ:INTC) and Texas Instruments (NASDAQ:TXN), fit that description. They both generate a lot of cash flow and return a hefty portion to investors through competitive dividend yields.
Let's dig deeper into Intel and Texas Instruments to determine which semiconductor giant might be the better dividend stock to buy.
Cash flow keeps rolling in
Intel and Texas Instruments have both done well this year from a fundamentals perspective. Halfway through the company's fiscal year, Intel revenue was up 4% and earnings per share increased 16%. In the first six months of the year, Intel's free cash flow totaled $3.4 billion, which was actually down 16% versus the same six months last year.
Intel is spending more in an effort to finally expand beyond the personal computer, which has been its bread-and-butter business but is stagnating due to the smartphone boom. Intel's PC client group operating segment still accounts for more than 60% of the company's total revenue, which explains why capital expenditures are rising faster than sales. These investments in new products should pay off for Intel down the road, but its near-term dividend growth prospects are taking a hit.
It's clear that this has taken a toll on Intel's dividend growth. Big Blue is reserving more cash for research and development, and it hasn't raised its dividend in more than two years. But Intel distributes only about two-thirds of its free cash flow, so there's room for a modest increase in the near future should management decide to be less conservative in this area.
Texas Instruments holds an advantage
Texas Instruments' dividend yields 2.5% at its Sept. 15 closing price, which was just slightly lower than Intel's 2.6% yield at that day's closing stock price. But Texas Instruments has increased its dividend by 22% compounded annually over the past five years. This is far better than Intel's 10% dividend growth rate over the same period.
The main reason for this difference is that Texas Instruments is putting up better growth. Revenue and earnings per share grew 8% and 7%, respectively, over the first half of the year. Over the last 12 months, Texas Instruments generated $3.1 billion of free cash flow, representing 10% growth over the previous year. In addition, the company has more flexibility to increase dividends, because it distributes less than half of its free cash flow.
Texas Instruments is putting up solid growth, thanks to its highly successful analog and embedded processing group, which represents 82% of the company's revenue. Texas Instruments is seeing strong results in areas such as power management, which is fueling its solid growth. This is why its management has the confidence to aggressively raise the dividend, while Intel is taking a more cautious approach.
The winner: Texas Instruments
Both Intel and Texas Instruments offer solid dividend yields that are backed by sufficient cash flow. But Intel is at a disadvantage. Its investments in new areas, such as tablets and the Internet of Things, suggest a promising future for the company. However, the higher expenses necessary for innovation mean shareholders will have to make do with lower dividend growth.
Texas Instruments is doing better. Its dividend growth rate is higher, and it pays out a lower percentage of free cash flow than Intel does. This means Texas Instruments will likely continue its higher rate of dividend growth for the foreseeable future. For these reasons, Texas Instruments is the way to go for dividend investors.
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.