Want a reason to be wary of technology companies? The high-tech sector is the most likely place for investors to get jacked around by uncaring and even fraudulent management. The worlds of biotech research, semiconductor wafer production, optical networking devices, and more all swell with businesses backed by investors who have no idea what they own.
Unfortunately, this leaves the door open for executive leaders who are more interested in share-floating than operational follow-through. Don't think that WorldCom alone perpetrated fraud at the turn of the millennium. There were dozens upon dozens of minor and undetected criminal acts by executives serving themselves rich rewards, fudging their financial statements, and making misleading statements to shareholders. The latest disappointments involve the options backdating scandal, and criminal indictments have already been handed out to former executives of Brocade Communications and Comverse Technology. More than 100 firms are being looked at by the SEC, including heavyweights like Cablevision
So how can you invest in a technology company, or any public company for that matter, and feel confident that management treats you like a friend rather than a foe?
The power of pennies
One answer is to look for companies that pay dividends. Business professor and acclaimed author Jeremy Siegel advocates this practice, as do many other investing masters. Why? Because the simple act of paying those pennies per share out of earnings and savings to minority shareholders is a demonstration of partnership and teamwork. It represents at least some commitment on management's behalf to run a consistently excellent and stable business.
It's also no secret that dividend payers tend to perform better in the long run. Siegel found that Philip Morris, now Altria, was the top-performing S&P 500 stock from 1957 to 2003, turning $1,000 into $4.6 million. What's more, the entire top 20 consisted of dividend payers, as well as most of the rest of the top performers -- boring-yet-fruitful investments like Motorola
Another company with a long dividend history is Automatic Data Processing. This true American success story was trading for a split-adjusted $0.73, with sales of around $100 million, when it paid its first dividend in 1974. Today, with $8.9 billion in sales and a stock price near $47, the payroll processor has risen 64 times in value in 32 years.
The ADP story points out that as indicators of quality, dividends may be most telling in the world of small caps. Tom Gardner, for example, told his Hidden Gems subscribers that he loves to see a debt-free small company paying some sort of dividend, because to do so, it must have long-range visibility on profits.
Given that such visibility indicates stability, a dividend is one factor that can help you sort out the haves (small caps heading for mid- or large-cap land) from the have-nots (small caps heading to zero).
Thus, many of Tom and Bill's recommendations are sporting dividends -- like student loan evaluator First Marblehead
Where to find 'em
Companies that pay dividends aren't automatically friendly to their outside owners. But we think dividends are one of the great indicators of small-cap quality, and that principle has helped us achieve 31% average returns in Hidden Gems since the service began, versus 17% for equal amounts in the S&P 500. If you'd like to join us for a look at all our recommendations -- plus Tom's top five stocks to buy now -- it's free. Here's more information.
This article was originally published on Aug. 17, 2006. It has been updated.