Snapshot

Managers' views

Why “old tech” might surprise income investors


Mina Shankar

Mina Shankar

Analyst, Multi-Asset Investments

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John Cooper

John Cooper

Product Executive, Multi-Asset

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What’s happened?

For decades, dividends have largely been associated with companies from more mature areas of the market such as utilities or telecommunications. Meanwhile, technology has long remained an afterthought. But what happens when tech grows up?

Areas of the sector are beginning to mature, with names such as Microsoft, Oracle, and Intel distributing an increasing proportion of their earnings to shareholders. For income investors, the numbers are compelling.

Zoning in on the US tech sector, since 2007:

  • The income paid to investors has risen from $64 billion to $396 billion.
  • The proportion of earnings paid out as income (the payout ratio) has risen from 11% to 36%.
  • The share of total dividends paid as a proportion of the overall market has tripled from 5% to 15%.

Dividend yield is only half the story

We have long warned investors of the dangers of focusing on headline yield in isolation, particularly the risk of falling into value traps. Conversely, opportunities may be missed if a starting yield appears too low.

This is the case with US tech stocks. If we look at total yield, i.e. both dividends and share buybacks, income investors will undoubtedly be pleased with a healthy 4.1% versus a rather uninspiring 1.4% dividend yield.

Making the distinction between old and new

Given the differing characteristics and dispersion in valuations, it is important income investors remain highly selective in their approach, and make the distinction between 'old' and 'new' tech stocks. Old tech stocks typically pay a dividend, while new tech stocks do not. New tech currently trades at an expensive 41x earnings, versus 21x for old tech.

The story in charts

The tech sector distributes more earnings through buybacks than non-tech sectors.

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At the same time, its share of total dividends paid continues to grow.

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The supply of tech companies paying dividends continues to rise.

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Investors need to be selective, given the vastly different characteristics of payers and non-payers.

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Looking ahead

Schroders' multi-asset income team is a firm believer that investors need to look beyond headline yield. Instead the focus should be on the sustainability of the income stream and potential for income to grow.

From this angle, old tech remains highly attractive as more tech names move up the quality spectrum; stable, predictable cash flows enable management to distribute a higher proportion of their earnings.

Payout ratios in the US tech sector stand at just 36%, providing plenty of room to grow, compared to traditional income payers such as utilities at 74% and telecommunications at 69%. However, valuations within new tech are almost double that of old, meaning a highly selective approach is required within the sector.

 

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