Published on June 2nd, 2018 by Josh Arnold
Technology stocks tend to see more volatility during the business cycle than other sectors, like consumer staples, for instance. With that said, the technology sector has tremendous upside.
Volatility can be put to good use by investors that are interested in owning big technology securities by buying at trough valuations and avoiding those trading in excess of fair value.
In addition, the largest stocks of the group often pay very respectable dividends, which help to smooth out total returns rough periods. Payout ratios tend to be lower for technology stocks as well so the dividends offer a lot of safety during downturns, increasing their appeal.
You can download the complete list of all dividend paying technology sector stocks available on the big US market exchanges at the link below:
The rankings in this article are derived from our expected total return estimates from Sure Analysis Research Database. The 10 largest dividend paying technology sector stocks by market cap are ranked in this article, with #10 having the lowest expected total returns and #1 having the highest.
Rankings are compiled based upon the combination of current dividend yield, expected change in valuation as well as forecast earnings-per-share growth to determine which stocks offer the best total return potential for shareholders.
Read on to see which of the ten largest Technology stock ranks as the most attractive for investors today.
#10 Best Big Tech Dividend Stock: Qualcomm (QCOM)
Qualcomm traces its roots back to 1985 when it was founded to produce a service that trucking companies could use to locate and message drivers. It now sells integrated circuits for use in voice and data communications, which has afforded it $16B in annual revenue and an $86B market cap.
Qualcomm’s recently reported 2nd quarter showed earnings of $0.80 per share, well in excess of estimates. Revenue declined 13.2% year over year to $5.2 billion, but came in slightly ahead of expectations. Sales declined mostly due to the lack of royalty payments made by Apple’s manufacturers. Qualcomm has made some concessions in hopes of ending its feud with Apple, including offering a lower-cost license on devices that use the company’s patented products. In addition, President Trump issued an order on 3/12/2018 that blocked Qualcomm from being acquired by Broadcom (AVGO) due to national security issues.
QCOM’s dividend is certainly a big draw for investors as even after the recent rally in the stock, it comes in at 3.8%. QCOM has a fairly long history – among tech stocks, that is – of paying a sizable and rising dividend and that is the main source of appeal in the stock as of now.
Source: Q2 Earnings Presentation, page 8
The slide above from the company’s Q2 earnings presentation shows just how important the dividend is to the management team. We’ve seen the dividend essentially quadruple in the past decade, making QCOM one of the premier dividend stocks in the tech space over that time frame. That has led to its very high yield today and cemented its status as a relatively rare income stock in its sector.
We see the dividend as continuing to increase going forward, although the pace of those increases is likely to slow down somewhat as QCOM already spends roughly two-thirds of its earnings on the dividend, leaving less room for additional growth in the future. QCOM is a Dividend Achiever, a select group of 200+ stocks with 10+ consecutive years of dividend increaeses. You can download an Excel spreadsheet of every Dividend Achiever below:
Qualcomm’s earnings per share declined almost 16% during the last recession. Even with this sharp decline, the company has grown earnings per share at a rate of 6.6% per year over the last decade. Much of this growth has taken place in the early part of the current decade as royalty payments from 3G and 4G networks accelerated. The nonpayment of royalties from Apple has had a significant impact on Qualcomm’s earnings recently, however.
Qualcomm increased its offer for NXP Semiconductors (NXPI) to $127.50 per share from $110. The company is still waiting for regulators in China to sign off on the deal, though the country approved of a joint venture between the company and state-owned Dtang Telecom. The $44 billion dollar acquisition of NXP will help Qualcomm diversify its business into automotive and personal security markets, should it be allowed to go through. Given the dispute with Apple and the not-yet-completed NXP deal, we see EPS growing at the below average rate of 4% per year.
Qualcomm has had an average price-to-earnings multiple of 15.8 over the last decade. Given the uncertainty around its disagreement with Apple as well as its pending purchase of NXP, we assign target multiple of 14. A successful conclusion to either of these issues would likely mean a higher target multiple, but significant uncertainty is weighing heavily in QCOM at present. We therefore see QCOM as trading at fair value today, meaning total returns are unlikely to be impacted by a change in valuation in the coming years, pending what happens with its Apple case and the NXP transaction.
Shareholders of Qualcomm can expect total annual returns of 8.4% through 2023. This is made possible by the combination of modest growth in EPS of about 4% as well as the current dividend yield. While we feel that the current multiple is an appropriate target, there is a possibility of P/E expansion if Qualcomm is able to resolve its dispute with Apple over royalties and earn approval from China for its purchase of NXP Semiconductors. Qualcomm is an interesting stock that is likely to see its total returns driven by the situations discussed previously rather than general market growth. While we don’t recommend it as an outright buy today, it certainly has potential because of its positive expected total return and non-market driven catalysts. QCOM is also a true income stock in a sector that isn’t typically known for such things, and we see QCOM as a strong choice for income investors.
#9 Best Big Tech Dividend Stock: Cisco (CSCO)
Cisco Systems is the global leader in high performance computer networking systems. The company’s routers and switches allow networks around the world to connect to each other through the internet. Cisco also offers data center, cloud and security products. Today, Cisco employs more than 72,000 people and has a market cap of more than $200 billion on about $50B in annual revenue.
Cisco recently reported Q3 earnings of $0.66 per share, slightly ahead of estimates and a 74% improvement from Q3 2017. Cisco grew revenues 4.4% to $12.5 billion, marginally above estimates. One area that should interest investors is that the amount of deferred revenue from subscriptions services totaled $5.6 billion in Q3, which is an increase of 29% year over year.
Cisco’s capital allocation strategy has been extremely shareholder friendly since its inception – it only began paying dividends in 2011 – and today, this is a primary reason investors own the stock. The dividend has increased more than 800% since its inception only seven years ago and today, Cisco yields in excess of 3% in a sector where income stocks are relatively scarce.
Source: Q3 Earnings Slides, page 13
In addition, as this slide shows, Cisco is very active in the repurchasing of its own stock. The past four quarters have seen Cisco spend a staggering $12.8B on repurchases in addition to the $6B it has returned to shareholders via the dividend. The dividend was just raised as well from 29 cents quarterly to 33 cents, showing once again that Cisco is very shareholder-friendly.
Cisco has managed to increase earnings every year since the Great Recession. Helping EPS growth was its massive share repurchase program, retiring of more than 900 million shares over the past decade. Cisco has seen earnings grow at an average rate of more than 6% per year over the past decade and based on this historical growth rate, as well as the company’s earnings guidance for 2018, Cisco could earn $3.47 per share in 2023.
With everything from computers to cell phones to buildings to motor vehicles connected to the internet today, Cisco is in a prime position to capitalize on the Internet of Things trend. In fact, Cisco is responsible for 80% of all the data moved over the internet in the past 30 years. While Cisco continues to enjoy hardware dominance, the company is attempting to become more of a subscription services company. Indeed, its Q3 earnings showed that subscription revenue continues to grow and is now almost one-third of its total top line; this should help create more predictable revenue streams.
The 2008-2010 time frame saw shares of Cisco trade with a P/E multiple that was much higher than it has been in more recent years. Excluding 2008-2010, shares have an average P/E of 11.5. The market has caught onto Cisco’s subscription model and has bid shares up recently to its current P/E multiple of 16.6. Even after the nearly 4% decline after Q3 earnings were announced, shares are up almost 40% since the beginning of 2017. Given the company’s growth in subscription services and large cash balance of more than $50 billion, we have a target P/E of 15 for 2023. If Cisco’s stock was to revert to our target multiple, shareholders could see the P/E multiple contract by 2% per year through 2023.
Even after the earnings price decline, we still feel the stock trades above its fair price to earnings multiple. We believe that Cisco can offer total returns of 7.1% per year through 2023. This annual return is a combination of earnings growth of 6%, the current dividend yield of 3.1%, and multiple contraction coming to 2% annually. Cisco therefore offers income investors a strong current yield and dividend growth, while those seeking value or earnings growth are likely better off looking elsewhere.
#8 Best Big Tech Dividend Stock: Intel (INTC)
Intel is the largest manufacturer of microprocessors for personal computers in the world, as it ships about 85% of the world’s microprocessors. Intel also manufactures products like servers and storage devices that are used in cloud computing. It employs more than 100,000 people worldwide and has a current market cap of almost $260 billion on about $68B in annual revenue.
Intel’s recently reported Q1 earnings showed EPS of $0.87, which beat estimates by $0.15 and was a 32% improvement from last year’s comparable quarter. The company saw revenue growth of nearly 9% YoY to $16.1 billion, which was more than $1 billion above expectations, and it issued strong guidance. A lowered tax rate added $0.30 to 2018’s EPS midpoint, which now stands at $3.85. All of the company’s divisions showed growth in the quarter, with the data-centric business growing 25% and approaching 50% of total revenue.
Source: Q1 Earnings Presentation, page 6
This slide shows that an important piece of Intel’s earnings outlook is its continued focus on lowering costs, which it is doing very well. Q1 saw operating margins rise by 3%, an impressive feat accomplished by disciplined R&D as well as SG&A spending, something we expect will continue.
Along with most companies in the market, Intel’s earnings declined during the last recession, though the company rebounded to growth the following year. Earnings growth over the past decade has averaged a very impressive 14% annually. Since 2010, however, EPS has grown at a lower rate of 7% per year. Applying the growth rate of 7% to the midpoint of Intel’s guidance for 2018 and shares could see EPS of $5.40 by 2023.
For some time, the PC business has been challenged, but this segment managed to grow 3% in the quarter. However, what should really interest investors is Intel’s data-centric businesses. This division supplies storage, servers and products that are related to the Internet of Things. All combined, this division was up 25% in Q1. These products are growing at a fast rate and should for the foreseeable future, fueling near term growth in the company’s earnings. While growth for the PC business is welcomed, it is the data-centric products that will be a real driver of growth.
Shares of Intel traded with an inflated P/E multiple in 2008 and 2009 due to steep earnings declines. Since 2010, shares have traded with an average multiple of 11.7. Based off the strength of Intel’s data centric growth and PC business improvements, we feel shares deserve a slightly higher target multiple than its historical average. If shares were to revert to our target P/E of 13, the stock could experience a multiple contraction of 1.5% per year through 2023 given its current P/E multiple of 14.
Intel shares have increased almost 50% since the start of 2017. This share price advance has reduced our annual return estimates to 7.7% per year through 2023. This estimate is a combination of earnings growth of 7%, the current 2.2% yield and multiple contraction of -1.5%. This type of return with solid dividend growth potential will not likely be of interest to those investors seeking high growth and the current P/E multiple will likely not interest those seeking value. The current yield is well below the historical average, so income investors might want to elsewhere as well. On the positive side, Intel has a lot of cash on hand, a low dividend payout ratio, impressive interest coverage and just raised guidance for Q2 and 2018. Intel offers solid total return over the next five years, but is a hold at current prices.
#7 Best Big Tech Dividend Stock: Apple (AAPL)
Apple is a technology company that designs, manufactures and sells products such as smartphones, personal computers and portable digital music players. Apple also has a thriving services business that sells music, apps and other content. Apple was founded in 1976, produces $260B in annual revenue and is currently valued at a market cap of $925 billion.
Apple’s most recent quarterly results were strong once again as the company reported earnings per share of $2.73, an increase of 30% year over year. Revenues during the quarter totaled $61 billion (up 16% year over year), building upon the continued strength of the company’s iPhone business as well as its vast services catalog.
Source: Company website
Apple’s capital returns are the stuff of legends as it has managed to return cash to shareholders in the hundreds of billions of dollars. The company’s buyback has been instrumental in vastly reducing the share count and the company just added another $100B to its authorization, so continued reductions in the number of shares outstanding is all but assured.
In addition, its dividend history has been short but meaningful, although the recent rally in the stock has the yield below the broader market at just 1.6%. Apple has committed to returning cash to shareholders in a big way and this will continue over the next few years at least, boosting total returns.
Since 2012, Apple’s profits per share have grown by 7.9% annually, although that is substantially lower than the growth rates Apple produced prior to that time. Going forward, Apple’s earnings growth will be driven by several factors, one of which is ongoing iPhone releases. In the US and other developed countries, the market is relatively saturated but in emerging countries, where consumers have rising disposable incomes, Apple can increase the amount of smartphones it is selling.
Apple also has been increasing the selling prices of its phones over the last couple of years, which drives revenues further. Another avenue for growth is Apple’s services segment, which consists of iTunes, Apple Music, the App Store, iCloud, and Apple Pay. It recorded a 31% revenue increase during the most recent quarter and the services segment produces close to $40 billion in annual revenues alone. Services revenues are growing substantially more quickly than all other segments, and at the same time this business produces recurring revenues and is not dependent on ongoing successful rollouts of new products (contrary to the iPhone, iPad & Mac business units). Given all of these factors, we see Apple growing EPS at 8% annually going forward.
Apple’s price-to-earnings ratio has been surprisingly low since 2009 given that the market simply did not expect the company to continue to grow steadily. The company’s current P/E multiple of 16.6 compares slightly unfavorably to our fair value price-to-earnings ratio of 15.5, implying an annual headwind of just 1.4% as the valuation drifts back down to more normalized level.
Overall, we see Apple as slightly overvalued and thus, we foresee total annual returns of 8.2% going forward, consisting of the current 1.6% yield, 8% EPS and a 1.4% headwind from the valuation. That wouldn’t make Apple particularly attractive here as it lacks strong value, it should grow at moderate rates and its yield is below that of the market. Thus, those interested in Apple would do well to wait for a better price.
#6 Best Big Tech Dividend Stock: Microsoft (MSFT)
Microsoft develops, manufactures and sells both software and hardware to businesses and consumers. Its offerings include operating systems, business software, software development tools, video games and gaming hardware, as well as cloud services. Microsoft was founded in 1975 and is currently trading at a market capitalization of $752 billion on more than $100B in annual revenue.
Microsoft’s most recent quarterly results were announced on April 26. The company’s Q3 results included EPS of $0.95 (up 36% YoY) and revenues of $26.8 billion, up 16% YoY. Another highlight from Microsoft’s most recent earnings call was its massive operating cash flows of $12.2 billion and cash holdings of $132 billion.
As seen above, MSFT’s growth continues to come from all of its business segments. All three of its major segments produced mid-teens growth rates in revenue and gross margin dollars, and prudent spending led to a 2% increase in its operating margin rate. MSFT’s Q3 earnings were really quite superb and its enormous boost to EPS was proof of that.
MSFT has roughly quadrupled its dividend in the past decade as it has continued to use excess cash to reward shareholders over the years. We see the current yield of 1.7% as unsustainable low and expect the growing payout as well as a stock we see as trading above fair value to combine to send the yield back up to a more normalized level of 2.3% over the coming years. MSFT remains a very strong capital return story with both the dividend and the buyback, and given its prodigious cash flow, we don’t see any reason that won’t continue.
After years of solid growth, Microsoft was having a hard time growing its profits further during the 2011-2015 time frame, but after some change in its management and a strategic shift towards cloud computing and mobile, Microsoft’s growth was reinvigorated. Growth rates for revenues and profits are at high levels, thanks to several factors.
The cloud business is growing at a mid-teen range thanks to Azure, which combines IaaS, PaaS & SaaS offerings and which has been growing at a 90%+ rate for ten quarters in a row. Microsoft’s Office product range, which has been a low-growth cash cow for many years, is showing strong growth rates as well after Microsoft has changed its business model towards the Office 365. Microsoft is also a key player in the gaming industry (with hardware as well as software offerings) and benefits from strong market growth in that industry.
Microsoft’s EPS are growing at a significantly faster pace than revenues due to three key elements. Rising margins, as software offerings come with high fixed but low variable costs, lower taxes and, last but not least, a shrinking share count. The markets Microsoft addresses continue to grow (with cloud computing being the most compelling), which means that even without any market share gains, Microsoft would be able to grow its top line. With the factors that grow earnings even further in place Microsoft’s growth outlook over the coming years looks quite compelling, although the company certainly will not be able to maintain a 30%+ EPS growth rate over the long term. However, we still see a robust 12.1% EPS growth rate moving forward from here given all the factors above.
Microsoft’s P/E multiple averaged 15.2 over the last decade, but shares are significantly more expensive right now. This is not surprising, however, as Microsoft’s growth outlook is much better than it was over the last decade. Going forward Microsoft will likely not see its valuation drop back to the mid-teens, as its strong position in growth markets such as cloud computing will allow for higher valuations going forward. However, we believe the current P/E multiple of 25.4 to be unsustainable and see a strong 5.1% headwind to total returns annually as it comes back down to 19.5.
Years of strong returns have left MSFT quite overvalued and thus, we think investors interested in the stock should wait for a better entry point. We see 8.7% total annual returns going forward, consisting of the current 1.7% yield, 12.1% EPS growth and a 5.1% headwind from the high valuation.
#5 Best Big Tech Dividend Stock: Oracle (ORCL)
Oracle is an IT company that provides software, hardware and services. Its offerings include applications, platforms and infrastructure technologies, hardware products such as servers, hardware-related software products, and services such as consultation & education. Oracle was founded in 1977 and is valued at $190 billion, producing about $40B in annual revenue.
Oracle’s most recent quarterly results were announced on March 19. The company reported earnings-per-share of $0.83, an increase of 20% year over year. The company also reported revenues of $9.7 billion, an increase of six percent over the prior year’s quarter. Oracle’s guidance for the current quarter shows revenue growth of 1% to 3% and earnings per share in a range of $0.92 to $0.95.
Source: Company investor relations
Oracle’s dividend has been rapidly increasing since its introduction almost a decade ago, and we see today’s payout as roughly doubling in the next five years. As a result, we expect the current 1.6% yield to gradually move higher to 2.1%.
From 2008 to 2014, Oracle managed 14% average annual EPS growth. However, profits peaked in 2014 and in the following years, it did not manage to grow its earnings further. This period was when Oracle had to refocus its operations as the whole software industry was moving towards the megatrend of cloud computing, but it looks like Oracle has successfully managed to direct its operations towards the cloud, as growth has accelerated again and profits will very likely come in at a new record level this year.
During the most recent quarter Oracle recorded a 32% cloud revenue growth rate – driven primarily by Cloud SaaS growth of 33% – and for the next quarter, Oracle has forecasted a cloud revenue growth rate in the low 20s. Infrastructure as a Service as well as Platform as a Service are markets that are growing at a fast pace, and Oracle’s CEO pointed out that the underlying growth rate for Oracle’s IaaS and PaaS offerings was 56% during the most recent quarter.
Oracle is also positively impacted by rising margins, as the company managed to keep its expenses relatively flat recently whilst revenues continued to grow. Despite a high amount of new shares being issued to employees and management, Oracle’s share count has been declining over the last couple of years thanks to billions of dollars being spent on share repurchases. This drives EPS growth further, and thanks to strong cash flows, Oracle should be able to continue to reduce its share count in the future. Given all of these factors, we see Oracle as producing 7.3% annual EPS growth going forward.
Oracle was valued relatively inexpensively during the 2008-2014 time frame, despite its strong growth rates during those years. More recently, shares have become a little bit more expensive as investors began to anticipate the positive impact of a strategic shift towards cloud computing. Right now Oracle is valued almost exactly in line with its historic average & median earnings multiples and thus, we see basically no impact from the valuation on total returns.
Speaking of total returns, we see 8.8% annually for Oracle going forward. This will consist of the current 1.6% yield, 7.3% EPS growth and a 0.1% headwind from the valuation. That makes Oracle a decent choice for growth or value investors, although it looks like a hold here.
#4 Best Big Tech Dividend Stock: NVIDIA (NVDA)
NVIDIA Corporation is a specialized semiconductor company that designs and manufactures graphics processors, chip sets and related software products. Its products include processors that are specialized for gaming, design, AI data science and big data research, as well as chips designed for autonomous vehicles, robots, and more. NVIDIA was founded in 1993, produces $13B in annual revenue and is valued at $150 billion.
NVIDIA’s most recent quarterly results were strong as the company reported earnings per share of $2.05, an increase of 141% YoY. This immense earnings growth was accompanied by a revenue increase of 65%, to $3.2 billion. Guidance for Q2 sees revenues of $3.1 billion, a small decrease compared to Q1 results, but ahead of what analysts had expected.
NVDA produced record revenue, gross margin, operating income and EPS last year as a result of its significant growth drivers; this company is fully capitalizing on its exposure to several key markets like autonomous cars, cloud computing and gaming and the results have been extraordinary.
NVDA began paying its dividend in 2012 and growth has been rapid since that time. However, given the meteoric rise in the stock, the yield is currently just 0.2%. We see the dividend roughly doubling in the next five years but that should be good for a yield of just 0.6%, meaning NVDA isn’t and likely won’t be an income stock for a very long time to come, if ever. This is not a stock one buys for the yield.
NVIDIA has been a very successful player in the graphic processor (GPU) industry. Recently, NVIDIA’s growth exploded due to two main trends. First, cryptocurrencies have become more common, and miners who want to mine often do this with graphic processors. This has driven demand for top-tier GPUs over the last year, which is one of the reasons why NVIDIA was able to grow its GPU revenues by 77% during Q1. NVIDIA offers crypto-specific GPUs, but demand from miners is somewhat cyclical depending upon market prices for cryptos. NVIDIA has also found out that its GPUs are very versatile in AI applications: This came as a surprise to NVIDIA as well, but the company has immediately started to capitalize on this trend by offering GPUs that are optimized for deep learning purposes, where these GPUs act as the brain of computers, robots, and self-driving cars. Those GPUs are utilized in professional visualization, data centers and automotive markets.
All of the markets NVIDIA supplies GPUS for have strong growth rates, which bodes well for NVIDIA’s revenue outlook – even without significant market share gains the company should easily be able to capitalize on growing demand from gamers, professionals, cryptocurrency miners, and scientists. NVIDIA recently has been able to grow its profits a lot faster than its revenues, which can be explained by operating leverage and improving economics of scale. Going forward this should help NVIDIA to achieve above-average earnings growth rates as well. NVIDIA’s forecasts show that it has a lot of potential to grow its revenues over the coming years. Even though NVIDIA has bought back shares occasionally, its share count has actually increased over the last five years. Given all of these factors, we’re forecasting 15% annual EPS growth for NVDA going forward, making it one of the fastest growing stocks in our coverage universe.
NVIDIA’s valuation has increased significantly since 2014. This was the point where NVIDIA transformed from a gaming-focused GPU producer into a company that sells its products to many different industries. The improved growth rates (and outlook with substantially bigger addressable markets) has led to a revaluation that has made NVIDIA’s shares rally. Its current valuation will likely not be sustainable in the long run, but due to its high growth rates and strong outlook NVIDIA will likely continue to trade at an above-average valuation for the foreseeable future. We see the current PE multiple of 36.4 as unsustainable and forecast it to fall back to 25, implying a sizable 7.2% headwind to total returns as a result.
Overall, we are forecasting NVDA to produce 8% total returns annually over the next five years, consisting of the 0.2% current yield, 15% EPS growth and a 7.2% headwind from the valuation that we see as moving lower over time. NVDA would therefore be appropriate for those investors seeking high rates of growth, but wouldn’t appeal to those seeking a high yield or value, as NVDA offers neither.
#3 Best Big Tech Dividend Stock: Texas Instruments (TXN)
Texas Instruments is a semiconductor company that operates two business units: Analog & Embedded Processing. Its products include semiconductors that measure sound, temperature and other physical data and convert them to digital signals, as well as semiconductors that are designed to handle specific tasks and applications. Texas Instruments was founded in 1930, produces about $16B in annual revenue and is currently valued at $109 billion.
Texas Instruments’ most recent quarterly results were announced on April 24, the company earned $1.21 per share and revenues of $3.8 billion, an increase of eleven percent year over year.
Source: Investor Presentation, page 19
TXN’s tremendous earnings growth over the years has afforded it the same sort of expansion in its FCF, which has averaged 13% annually since 2004. Last year’s numbers were even better as its FCF margin increased to a staggering 31.2% and its FCF/share was up almost 16%. These numbers give TXN lots of flexibility when it comes to capital allocation, and shareholders have been rewarded as a result.
TXN’s dividend has increased more than 500% since 2008 and today, the stock yields 2.2%. That’s roughly in line with its historical yields but we see the dividend rising substantially in the coming years as TXN continues to pass its prodigious FCF on to shareholders, seeing the yield rise to 2.5% as a result.
Texas Instruments results are somewhat cyclical, which isn’t a surprise as demand for semiconductors usually depends on the strength of the economy overall. From 2008 to 2017 Texas Instruments has grown its earnings per share by 12.0% annually, which includes the earnings decline during the last financial crisis.
When we look at Texas Instruments’ Q1 report we see several factors that contributed to higher earnings per share, the first one being higher revenues. Revenues in the Analog segment grew 14% YoY, while Embedded Processing revenues grew by 15%. Demand for Texas Instruments’ products has been especially strong in industrial and automotive markets.
Thanks to higher production volumes Texas Instruments has also been able to grow its margins further during the most recent quarter, as operating expenses don’t grow much when output rises, the company’s high gross margins (of more than 60%) provide strong operating leverage that allowed for a 24% operating earnings increase in Q1, which compares quite favorably to the 11% growth rate for revenue. A lower tax rate has further increased TXN’s net earnings, and the company has guided for a tax rate of 20% in 2018 and just 16% in 2019, which should boost net earnings growth over the coming two years.
Last but not least, Texas Instruments’ policy of returning all free cash flows to the company’s shareholders in the form of dividends and share repurchases affects its earnings per share growth positively. Texas Instruments has bought back 43% of all shares since 2004, but even at the more recent pace of about 3% annually, these share repurchases lead to a substantial amount of additional EPS growth.
TXN’s current PE multiple of 22.9 is well above its historical averages and we see it drifting lower to 19 over time. This implies a headwind of 3.7% annually as the valuation resets lower, negatively impacting total returns.
However, we still see total returns moving forward as very strong for TXN, producing 9.5% annually. This will consist of the current 2.2% yield, 11% EPS growth and a 3.7% headwind from the valuation moving lower. This would make TXN a decent choice for those seeking income and/or dividend growth as well as earnings growth, but TXN is trading in excess of fair value.
#2 Best Big Tech Dividend Stock: International Business Machines (IBM)
IBM is an information technology company that provides integrated solutions that leverage information technology and knowledge of business processes. The company was founded in 1911 and produces about $80B in revenue annually. Today, it has a market capitalization of $131 billion.
Back in April, IBM reported first-quarter earnings results. It had earnings-per-share of $2.45 on revenue of $19.08 billion. IBM’s revenue increased 5.1% year-over-year, making two quarters in a row of revenue growth. For most companies, this might not be a huge achievement, but IBM was coming off a streak of 20+ consecutive quarters of declining revenue. Adjusted earnings-per-share increased 4% from the same quarter a year ago.
Among IBM’s various segments, the Global Business Services segment was the notable decliner, with revenue down 1%. This segment includes consulting, global process services, and application management. The Technology Services and Cloud Platform was also down 1% for the quarter. Helping to offset this was a 2% revenue increase for Cognitive Solutions, while Systems revenue increased 4%.
Source: Q1 Earnings Slides, page 17
As we can see above, IBM’s business, while improving, continues to be a mixed bag of strength and weakness. Its Strategic Imperatives are driving growth but legacy businesses are largely offsetting that growth, resulting in not only roughly flat revenue, but margins as well. IBM is having a difficult time producing any sort of meaningful growth, although the outlook that was very negative for some time has at least stabilized.
IBM’s dividend has long been a significant reason for investors to own the stock and that is no different today. Its dividend has more than tripled since 2008 and we see that growth continuing as IBM raises its dividend to more than $8 per share in the coming years. The current 4.4% yield is high by historical standards but we see a rising valuation as offsetting growth in the payout and thus, the yield should drift lower to 3.9% over time. However, IBM is and will remain an income stock for the foreseeable future.
IBM enjoyed rapid earnings growth coming out of the Great Recession of 2008-2009. However, earnings growth reversed course starting in 2014, and declined each year since; it expects to finally return to earnings growth in 2018 and beyond. The key areas of growth for IBM are data, mobile, security, and analytics.
Strategic imperative and cloud revenue rose 10% last quarter, and is up to $37.7 billion in the trailing 12 months. Total cloud revenue increased 20%, as did the annual run-rate for as-a-service revenue. As the strategic imperatives become a larger part of the company, growth can finally offset declines in the legacy systems and hardware businesses. Last quarter, the strategic imperatives represented 47% of IBM’s total revenue. We expect IBM to return to modest growth over the next five years, due to the slow progress of the company’s turnaround thus far. Over the next five years, earnings growth and dividend growth are expected at 5% per year.
IBM’s current price-to-earnings ratio of 10.3 is below the historical valuation of the stock of 12.3, which is a reasonable estimate of fair value. IBM is going through a difficult turnaround, but it is a highly profitable company with a strong brand. A rising valuation should add 3.6% annually to total returns.
IBM has been a disappointing stock for several years, as the company struggled through a prolonged and difficult turnaround. Now that IBM has returned to revenue growth, it is likely to generate positive earnings growth over the next 5 years. Combined with a low valuation and high dividend yield, IBM is an attractive stock. We believe IBM can generate total annual returns of 13% over the next five years consisting of the 4.4% current yield, 5% EPS growth and 3.6% tailwind from a higher valuation. This would make IBM attractive for those seeking a high current yield, dividend growth or value, meaning we rate IBM as a buy today.
#1 Best Big Tech Dividend Stock: Applied Materials (AMAT)
Applied Materials began in a small office unit in 1967 and since that time, it has undergone some major, transformative changes. Those changes have afforded it some fairly spectacular rates of growth and today, it has a market cap of $53B and does almost $18B in annual revenue. AMAT has become a major player in the Semiconductor market, which makes up the majority of its revenue.
AMAT’s recently reported Q2 and subsequent guidance cut saw the stock take a hit, but overall, results were fairly strong. Revenue was up 29% YoY as each segment produced enormous gains, and operating margins grew nicely as they added 240 basis points during the quarter. AMAT also spent heavily on buybacks in Q2, reducing the float by about 4%.
AMAT’s longer term earnings performance is captured in the slide above and its growth has been nothing short of outstanding. Revenue essentially doubled in five years as did operating margins, producing 448% growth in EPS over that time frame. AMAT’s success has rewarded shareholders handsomely and while we aren’t forecasting another 448% gain going forward, AMAT’s days of growing substantially certainly aren’t over.
AMAT’s dividend hasn’t been a main driver of total returns and we don’t expect that will change. However, we do see meaningful growth in the payout from today’s 80 cents annually to $1.20 in the next five years. That won’t be enough to offset growth in the share price, however, and as a result, we think the current 1.6% yield will fall to 1% over time.
AMAT’s EPS history is volatile to say the least, as the company has seen EPS rise and fall very rapidly from year to year in the past decade. It remained profitable during the Great Recession, but still suffered a substantial decline in earnings. However, the quick recovery gave way to a multi-year decline in earnings, leading to disappointing performances from the stock. Since the bottom in 2013, AMAT has managed to see what can only be described as explosive earnings growth and for this year, we are projecting $4.40 in EPS. Further, we see continued upside to $6.90 in the next five years as AMAT manages to hit 9.4% average annual EPS growth.
This is a lofty but achievable goal given that AMAT has many levers it can pull to get there. First, revenue is moving substantially higher as volumes driven by television and mobile device manufacturers remains very robust. That higher volume is then leading to better operating margins from leveraging down expenses, something that AMAT has proven quite good at over the years. Third, gross margins continue to move higher, something we expect will continue, although this will not be a primary source of earnings growth. Fourth, AMAT is buying back a lot of stock, having spent billions of dollars in Q2 alone. It still has about $6B left on its current buyback authorization, good for about 12% of the float at today’s prices.
AMAT’s valuation has come well off of its highs of recent years and as of now, sits at just 11.4. That compares extremely favorably with its historical average closer to 17 and as a result, we see the PE multiple expanding back towards the average and providing shareholders with a substantial 8.1% tailwind to total returns.
AMAT is an attractive buy for long-term investors at current prices. We forecast annual returns of 19.1% consisting of the current 1.6% yield, an 8.1% tailwind from the expanding valuation and 9.4% EPS growth. This makes AMAT the most attractive large cap tech stock in our coverage universe, and we rate it a buy as a result.