Technology stocks historically haven't been associatd with dividends. But as the sector has matured, so too have the capital allocation policies of many large technology sector businesses.
Now there are many large tech stocks that pay dividends. Three worth looking into in greatr detail are:
- Applied Materials (AMAT)
- Texas Instruments (TXN, Financial)
- International Business Machines (IBM, Financial)
Business Overview
Applied Materials is a major player in the semiconductor industry. The company was founded in 1967 and has since grown to a $47 billion market capitalization with nearly $18 billion in annual revenue.
Texas Instruments is also a semiconductor company and was founded in 1930. Its market capitalization is $113 billion, and it produces $16 billion in annual revenue.
International Business Machines is a diversified information technology company, founded in 1911. It has grown to more than $80 billion in annual revenue and has a $134 billion market capitalization. All three companies offer different ways to own a piece of a large technology company with a respectable dividend.
Growth Prospects
International Business Machines is the weakest grower in this group of three as the company’s turnaround plans are still very much up in the air. The company has struggled in recent years with revenue production and as a result, earnings-per-share performance has been very weak. However, we see its prospects improving moving forward as it continues to capitalize on its strategic imperatives, driving revenue and margins higher in the process. In total, we believe IBM can produce 5% earnings-per-share growth annually in the coming years.
Texas Instruments has markedly better growth prospects than International Business Machines despite its very cyclical nature. Earnings-per-share have skyrocketed since the bottom in 2012 and while we do not expect earnings to triple again in six years’ time, we do see robust 11.5% annual earnings-per-share growth for the semiconductor company. Texas Instruments continues to grow revenue through higher volumes, particularly from industrial and automotive customers. This has helped boost margins as well as the company’s fixed and operating costs are leveraged down via higher revenue. Texas Instruments also returns a lot of cash to shareholders through buybacks and these factors combined should see Texas Instruments’ earnings-per-share materially higher moving forward.
Applied Materials continues to benefit from strong demand from its television and mobile device customers. Its exposure to the booming smartphone and tablet markets has driven earnings-per-share growth in recent years and should continue to do so. Increased volumes have driven operating margins higher, something we expect to continue. In addition, Applied Materials also returns significant cash to shareholders, spending billions of dollars on buying back shares at low valuations. In total, we see Applied Materials growing earnings-per-share at 9.4% annually moving forward because of these inputs.
Valuation and Total Returns
Valuations in the technology space have diverged of late as some stocks have grown their prices rapidly while others have waned. The three stocks we’re looking at here have certainly found themselves in the latter category, producing some compelling valuations for two of them.
International Business Machines is trading for 10.6 times our 2018 earnings-per-share estimate, against a long-term average valuation of 12.3 times earnings. As a result, we see a 3.0% annual tailwind to total returns as we believe shares will drift back towards their historical norm in terms of valuation. The company’s dividend is also the strongest in this group as the stock yields 4.5% at present. That compares favorably not only to the broad market, but tech stocks in general and even the company’s own dividend history. Indeed, there has never been a better time for dividend investors to own International Business Machines.
Texas Instruments is the lone stock of the three that is trading in excess of our fair value estimate. Today, it is priced at 23.7 times this year’s earnings against a long-term average of 19.0. That implies investors should see a meaningful 4.3% headwind to total returns from a lower valuation in the coming years as the stock works off its overvalued condition. The yield is currently 2.2% for Texas Instruments, which is low by its own historical standards, and is largely the result of the high valuation. We believe Texas Instruments will prove a strong dividend growth story in the coming years, forecasting the payout to nearly double over the next five years.
Applied Materials is the most undervalued stock in this group, trading for 10.6 times our 2018 earnings-per-share estimate. This compares extremely favorably to the company’s long-term average of 16.8 times earnings and we believe this will be a primary driver of total returns in the next few years, adding 9.6% annually. The stock’s 1.7% yield is the lowest in this group as dividend growth hasn’t been a priority for management in the past. Instead, it has focused on growing the business and buying back shares so for income investors, Applied Materials likely isn’t the best choice.
In total, we see the following total returns for these three stocks in the next five years:
- International Business Machines: current yield 4.5%, earnings growth 5.0%, valuation 3.0%
- Texas Instruments: current yield 2.2%, earnings growth 11.5%, valuation -4.3%
- Applied Materials: current yield 1.7%, earnings growth 9.4%, valuation 9.6%
At 20.7%, Applied Materials offers investors the highest prospective total returns of this group over the next five years. Texas Instruments is well behind at 9.4% while International Business Machines offers investors 13.0% total annual returns. These three stocks offer investors high total return potential in very different ways. Applied Materials offers a mix of growth and value. Texas Instruments offers high rates of growth, but the valuation isn’t favorable right now. International Business Machines is in the middle of a turnaround effort but offers a level of value in addition to a very high current yield.
All three of these stocks offer investors strong prospective total returns but do so in very different ways. For value investors, Applied Materials is the best pick. If it is growth an investor is seeking, Texas Instruments is worth looking at. For dividend investors, International Business Machines is the most compelling choice.
Disclosure: I am not long any of the stocks mentioned in this article.
