Technology companies have always been known as growth engines that continually reinvest their profits into new cutting edge features, products or services that they believe will increase value for shareholders.
However, a new trend is emerging among several large-cap tech stocks: rewarding shareholders through share buybacks and returning cash in the form of dividends.
A new report out by Barclays notes that Apple (AAPL), Oracle (ORCL) and Cisco (CSCO) are leading this wave, and based on investor response, they expect several other tech companies will soon follow suit.
I have endearingly labeled these companies the “technology value sector,” which typically represents larger, established names with strong balance sheets and low debt ratios. Many of these companies have more cash than they know what to do with, which is why they are starting to return their profits to shareholders. This in turn creates a better value proposition for owning the stock and boosts investor demand.
I expect this new value proposition for technology stocks will directly benefit dividend-oriented exchange-traded funds such as the First Trust NASDAQ Technology Dividend Index Fund (TDIV). This ETF includes nearly 80 dividend-paying companies in the technology and telecommunications industries that have declared a distribution in the past 12 months.
The index TDIV is based off of uses a modified dividend-weighting methodology to determine the allocation of the underlying holdings. The top 3 holdings in TDIV include Microsoft (MSFT), Intel (INTC), and Cisco. The current 30-day SEC yield on TDIV is 2.62%, which doesn’t seem significant until you compare it to the Technology Select Sector SPDR (XLK), which is paying a yield of only 1.69%.
The performance comparison between the XLK and TDIV also is a compelling reason for investors to consider this fund. The total year-to-date return of TDIV is 18.1% compared to 12.1% for XLK. This is even slightly better than the returns of the more broadly focused iShares Select Dividend ETF (DVY) — a fund that features a small 5.65% allocation to tech and telecom stocks — which has gained 17.9% during that same time period, although its 3.58% yield is quite a bit higher.
It is important to note that TDIV still is a highly concentrated sector position and therefore should be evaluated within that context. It most likely will not take the place of a core position in your portfolio such as DVY, which has a much more diversified dividend makeup. In addition, TDIV has more exposure to small- and midcap companies than the large-cap weighted XLK, which might offer investors more balanced exposure to the technology sector.
I would expect that as the holdings within TDIV are analyzed on a quarterly basis, new stocks will appear based on this shift in strategy toward cash distributions. Two of the most notable technology companies that are missing from the dividend index that Barclays anticipates will boost their cash returns to shareholders are Google (GOOG) and Visa (V).
Investors still are hungrily seeking out equity income funds for their portfolio as they balance the need for capital appreciation with income generating opportunities. I believe TDIV represents an excellent opportunity for both growth and income investors, but with the market at its highs, I would wait for a pullback to enter the position. This will increase your odds of a successful long-term investment theme in dividend-paying technology stocks.
David Fabian is Managing Partner at Fabian Capital Management. As of this writing, he was long TDIV. Learn more by reading 3 Tenets Of Sound Risk Management.