TCS Daily

Tech Dividends

By James K. Glassman - August 21, 2000 12:00 AM

The value of any business is based on its ability to generate dividends for its owners. Period. Whether we're talking about Philip Morris (Ticker symbol: MO), which pays a whopping 7.5% of the value of each share in annual dividends, or Cisco Systems (CSCO), which currently pays no dividend at all, the valuations are still based on the companies' ability to generate dividends.

In Cisco's case, it's the expectation of future payouts that drives the stock. The company invests heavily in developing new products and shareholders are glad not to receive a regular check from San Jose. Why? They believe that CEO John Chambers can invest their money more productively than they can. Rather than taking the cash right now, Cisco shareholders want Cisco to continue innovating, with the expectation of a much larger score later.

Conversely, Philip Morris holders are not optimistic about the future of the cigarette business. They want the money now. The high dividend is the price that investors demand for accepting the gloomy prospects of the tobacco industry.

Since Americans are generally bullish on technology companies, as they should be, most of America's great tech companies don't pay dividends. Cisco, Microsoft (MSFT), America Online (AOL), and Sun Microsystems (SUNW) pay no dividends. Intel (INTC) pays a modest one, largely to be eligible for inclusion in mutual funds that require dividend-paying stocks. All of these companies use profits to enhance the value of their businesses. The money may be spent on strategic investments or acquisitions of valuable technology. Growing the business is, in fact, another way of paying dividends - making each share of stock more valuable. All things being equal, it's actually a better deal for shareholders. It means that when they eventually sell, they're taxed at a relatively low capital gains rate, as opposed to the higher rates for dividends, which are treated as income by the IRS.

Still, there are reasons to own dividend-paying stocks. You may want an income stream from your investments. Or you may think that, based on their dividends, some stocks are very attractively priced. Let's talk about a few stocks that may fall in that category. As we said, it's not easy finding a tech firm that pays dividends, and the ones that do generally don't have high yields (the percentage of the share price represented by the annual dividend). On my Glassman Tech Top 30 list, the highest yield (2.5%) belongs to AT&T (T). General Electric (GE), with a 1% yield, and Hewlett-Packard (HWP), delivering .5%, also pay dividends, but they're not very large.

One high-tech sector that does offer a lot of dividend-paying stocks is the defense industry. With Pentagon budgets beginning to rise again after the era of the peace dividend, some of these firms may be worth a look. Raytheon (RTN.A or RTN.B), which specializes in defense electronics and missile systems, would likely benefit if the United States chooses to deploy a national missile defense system. Right now, Raytheon yields about 3.5%, or 80 cents per share in annual dividends.

That may not seem like much when you compare it to the return on, let's say, a government bond. After all, you can have almost absolute security with a government bond and receive more than 6% per year. However, that annual payout will never increase and a government bond will only pay interest for 30 years.

A corporation could conceivably last for a hundred years or more, and it can increase its dividend many times along the way. In fact, over the last fifty years the average stock dividend has increased about 6.1% each year. To return to the Raytheon example, I have no idea how this firm will perform over the next ten, thirty, or a hundred years. But let's assume that you buy the company's shares today and that the firm will deliver absolutely average results, based on the recent history of the stock market. If Raytheon's 80-cent dividend grows 6.1% per year, it will double in a little less than 12 years, and double again in the 24th year. By the time a 30-year bond reaches maturity, when it will stop paying its 6%-plus annual return and return the principal to the investor, the annual Raytheon dividend will be $4.73 per share. In other words, you will be receiving better than a 20% annual return on the original investment - and the dividends can continue for the rest of your life and beyond if the company is well-managed. Of course, we're not even counting any appreciation in the value of the shares, which tends to happen over the long haul.

The historical record shows why stocks are so superior to bonds if you're able to invest for the long haul (and remember to diversify to limit your risk). Our example also shows why a good dividend from a boring defense contractor like Raytheon can lead to some very exciting returns.

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