As long as there have been dividends, there have been arguments between shareholders and company managers over whether to pay them. The strongest argument against paying dividends was profit growth: If a company can reinvest its earnings into more profits, the shareholder is better off in the long run.
Half a century ago, Ben Graham noted in
The Intelligent Investor
— considered by many the best book ever written on value investing — that in the early 20th Century, companies that forewent dividend to retain earnings were perceived as weak, and punished with sell-off. By the 60s, tech companies like Texas Instruments (TXN) and IBM (IBM) were growing so fast investors gave them a pass for paying little or no dividends.
“The better the past record of growth, the readier investors and speculators have become to accept a low-payout policy,” Graham wrote, with an almost audible sigh of disapproval. “It is our belief that shareholders should demand of their managements either a normal payout of earnings, or else a clear-cut demonstration that the reinvested profits have produced a satisfactory increase in per-share earnings.”
What did Graham consider a “normal payout of earnings”? Somewhere between 60% and 75% of a company’s net profit. Go ahead and laugh, because dividends have only grown smaller in recent decades. The average dividend-payout of S&P 500 companies has averaged 36% over the past 15 years. And at the end of last year, it was even lower: 29%.
Over the past two decades, investing earnings in buybacks or future growth has trumped the stodgy old dividend — and nowhere more so than in the tech industry. Dividends became a badge of dishonor in the 90s, a stigma that endured into the new century. Which is why it’s ironic that, in 2012, the dividend has been making something of a comeback in the tech sector.
The most notable case of a tech giant offering a dividend is Apple (AAPL), which announced in March its first dividend since 1995. For years, Apple’s former CEO Steve Jobs brushed aside calls for dividends, citing the old growth arguments: Apple needed its cash to compete, investing it in R&D or acquisitions rather than payouts to investors. But Jobs successor Tim Cook proved more amenable to a dividend as Apple’s cash holdings grew towards 12 digits.
Earlier this month, another computer manufacture, Dell Inc. (DELL), also said it would start paying a dividend. Unlike Apple, Dell wasn’t heeding investor demands to share the earnings wealth as much as it was supplicating them to hold steady through its turnaround efforts. Whereas Apple’s stock had risen 71% in the year before it announced its dividend, Dell’s stock had fallen 23%.
Apple and Dell are only the latest in a trend of large-cap tech stocks offering dividends. Cisco (CSCO) started offering one last summer. And according to Factset, 31 companies in the S&P 500 started paying dividends in 2010 and 2011 — eight of them tech companies. Ten years ago, only 18% of tech companies in the benchmark S&P index paid a dividend. Now that ratio stands at 54%.
And while dividend payouts may be declining among all industries, tech companies are offering beefier dividends to investors. Dividends per share among tech companies rose 24% last year to $4.55 a share. (Overall growth for the S&P 500 was 16%.) And this year, big tech has continued to raise dividends: Intel (INTC) by 7% and IBM by 13%.
The trend of higher tech dividends may have less to do with a sudden fit of corporate generosity, however, than the old-fashioned value investing that Ben Graham advocated. The price-earnings ratios of most large-cap tech stocks are low — inexplicably low, in ways that have puzzled analysts for a couple of years. Microsoft (MSFT), Intel, Cisco and IBM are trading between 9 and 11 times their forward earnings, according to Thomson Reuters. Even Apple, with annual revenue growth of 59%, has a forward PE of 11.
There are signs that, for tech companies at least, dividend payments will continue to accelerate, albeit moderately. Moody’s analyst Richard Lane noted in a report this month that dividend payments among tech companies covered by the ratings firm will rise 14% this year, above the 11% growth rate of the past four years.
But if tech is finally taking to dividends, the trend isn’t universal. No one expects recent listings like Facebook (FB) or LinkedIn (LNKD) to start paying a dividend any time soon. But even members the previous generation — eBay (EBAY) and Google (GOOG) — are holding out on paying dividends, despite cash piles that total $6 billion and $49 billion, respectively.
That points to another, contemporary aberration peculiar to tech — one that has less to do with growth and more to do with youth. After Apple, the argument against tech dividends isn’t so much about plowing earnings into the future as it is about retaining youthful appearances. The dividend is to middle-aged tech stocks what the grey beard is to middle-aged men: If you’re Apple or Sean Connery, you can pull it off. But if you’re not in shape — like Dell — or just not old enough — like Google — it just looks, well, lame.
As long as decent growth at tech companies is rewarded with a low price-earnings ratio, dividends are likely to keep rising. But investors will have to get used to these stocks less as capital-gains machines and more as steady dividend payers. It’s a bit of a shift in thinking, but one that Ben Graham would approve of.
And if that’s not enough, consider this. Even though more tech companies are paying dividends, and even though those dividends are on the whole getting bigger by the year, the tech sector is still pretty far behind in catching up to the mean. Tech companies still pay out only 15% of their earnings into dividends – below the 29% average for all industries, and certainly below the 75% that Ben Graham once dreamed of.
Which should be a wake up call to all shareholders of any large-cap tech stock: After two decades of stinginess, corporate managements are starting to unclench their hold on dividends. But there is a lot left in those Silicon Valley earnings that could be siphoned off into good old-fashioned investor dividends. The whining starts now.
Kevin Kelleher is a writer in the San Francisco bay area. You can tune into his intermittent whining on Twitter @kpkelleher.