Published on May 23rd, 2019 by Bob Ciura
Income investors can find quality dividend stocks from a wide range of market sectors, such as health care, utilities, and consumer staples. However, the technology sector still includes many large-cap stocks that do not pay dividends to shareholders.
Alphabet (GOOG) (GOOGL) is one of the ~90 stocks in the S&P 500 Index that remains a dividend holdout. You can see the entire list of S&P 500 stocks here.
But just because a company does not currently pay a dividend, does not necessarily mean it never will. Alphabet certainly generates enough free cash flow to support a dividend payout, meaning it theoretically could choose to start paying a dividend at any time.
While it is not a sure bet in the near-term, investors should not completely ignore the possibility of Alphabet joining the long list of dividend stocks at some point in the future.
Investors most likely know Alphabet by its former name, Google. It changed its name to more accurately reflect the fact that it has expanded well beyond its origins in search. It now exists as a conglomerate known as Alphabet. The stock trades under two share classes, an ‘A’ class and a ‘C’ class. The ‘A’ class, GOOGL, has voting rights, while the ‘C’ class, GOOG, does not. Alphabet is a massive technology giant, with a market capitalization above $800 billion.
Alphabet operates several businesses: Google search, Android, Chrome, YouTube, Nest, Gmail, Maps, and more. These businesses lead their respective categories, and continue to drive growth for the company.
In late April (4/29/19) Alphabet released first-quarter financial results. For the quarter, the company reported $36.3 billion in revenue, up 16.7% compared to the same quarter last year. Growth for the period was driven by a 15.3% increase in advertising revenue, which remains Alphabet’s largest source of revenue. On a constant-currency basis, first-quarter revenue increased 19%, a highly impressive growth rate.
Net income totaled $6.66 billion and earnings-per-share came in at $9.50, compared with earnings of $9.40 billion and EPS of $13.33 in the same period the previous year. On the surface, earnings declined significantly year-over-year, which would normally be a troubling sign.
However, a large part of the decline in the first quarter was due to a $1.7 billion fine from the European Commission. Without this fine, net income would have been $8.34 billion, with earnings-per-share of $11.90.
Still, even excluding the hefty fine, Alphabet’s EPS declined 11% in the first quarter. One major item that impacted Alphabet’s EPS was its effective tax rate of 18% in the first quarter, a significant increase from 11% in the year-ago quarter.
The good news is that Alphabet’s drop in first-quarter EPS was largely due to non-cash items, which are not expected to recur in 2020 and beyond. Importantly, Alphabet’s revenue continues to rise at a high rate, and the company maintains an impressive growth outlook.
There is little doubt that Alphabet was one of the best high-growth stocks of the past decade. From 2009 through 2018, Alphabet was able to grow earnings-per-share by an average compound rate of 17.5% annually. This is a highly impressive growth, as even 10 years ago Alphabet was a very large company.
Its growth was fueled in large part by its core search business, while newer platforms like YouTube have added to its growth. Going forward, although we do not expect Alphabet to maintain its huge growth rates of the past, we do believe the company can continue to grow at a satisfactory rate.
We expect 10% annual EPS growth over the past five years, focused on two specific growth drivers. First, Google remains the world’s dominant search engine, which generates a remarkable amount of cash. It is true that growth in search may slow at some point, but we see plenty of opportunity as the network effect continues to take hold around the world (making Google more and more valuable to advertisers with each additional user).
Second, the company makes significant investments in new technologies, through its operating segment known as Other Bets. This segment is where Alphabet makes high-risk, high-reward investments. Alphabet’s Other Bets include life sciences brand Verily and Google Fiber, which provides broadband internet services in the United States.
The Other Bets segment still represents a very small part of the company, but is growing at a high rate. First-quarter revenue from Other Bets increased 13.3%. And while many ventures inside the Other Bets segment will not pan out, others could propel Alphabet to its next major growth product or service.
In the meantime, Google’s core search business remains a cash cow with plenty of future growth potential. Additional growth is likely from Google’s other major businesses such as YouTube and Android. Google is still very much a growth company. And thanks to its huge size, it now has the financial strength to possibly pay a dividend to shareholders at some point in the future.
Why Alphabet Could Pay A Dividend
The main reason why companies do not pay a dividend is rather simple. Some companies simply cannot afford to distribute cash to shareholders. This is fairly common in technology, a rapidly changing and highly competitive industry that requires significant investment in growth. Many technology companies need to plow all cash flow back into the business to continue innovating to stay ahead of the competition.
However, Alphabet is far removed from its days as a startup. It is now a diversified tech conglomerate, with annual revenue above $136 billion. The company is also highly profitable. We expect Alphabet to generate earnings-per-share of $48.00 in 2019. Plus, Alphabet generates plenty of cash flow. The company generated free cash flow of $22.8 billion last year.
This would, in theory, allow Alphabet to pay a dividend if it chose to. For example, Alphabet could choose to distribute 25% to 30% of its annual EPS, which would still represent a fairly low payout ratio. In this case, the company would pay a dividend of $12 to $14.40 per share. Based on the recent Class C stock price of $1,151 per share, this would equal a dividend yield of 1% to 1.2%.
Alphabet would not be considered a high-yield stock by any means, but dividend-paying technology stocks rarely provide above-average yields. Fellow tech giants Apple (AAPL) and Microsoft (MSFT) have dividend yields of 1.7% and 1.4%, respectively. Alphabet’s projected dividend payout would put it roughly in-line with its closest peers. And, its future EPS growth would easily allow the company to raise its dividend at a high rate.
Finally, Alphabet’s fortress balance sheet provides another reason for the company to return cash to shareholders through a dividend. Alphabet ended the 2019 first quarter with $128 billion in cash, cash equivalents, marketable securities, and non-marketable investments on its balance sheet.
Alphabet has a mountain of cash piled up, and debt is not much of a concern. It ended last quarter with just $4.0 billion of long-term debt, giving the company ample liquidity to further support a dividend.
Like many technology stocks, Alphabet has never paid a dividend to shareholders. But as companies mature, and grow their profits and cash flow, their ability to pay a dividend rises as well. It appears Alphabet is easily able to pay a dividend; it simply has not made the decision to initiate a dividend yet. But this could change, which is why investors should not be surprised to see Alphabet start paying dividends at some point in the next several years.