North America's biggest technology companies have been largely ignored by investors in recent years, but their double-digit growth rates and billions of dollars of cash are beginning to attract increasing interest among value hunters.
Andy Miedler, an analyst with Edward Jones & Co. in St. Louis, points to three positives for the tech sector - a healthy outlook for growth, moderate valuations and a growing trend to pay dividends. "We think there is a lot of opportunity out there."
Since the tech bubble burst a decade ago, the technology sector has consolidated and large-capitalization companies have turned into cash machines. Software players such as Microsoft Oracle and IBM have enjoyed fat profit margins and a strong flow of recurring licensing revenue. Hardware companies, including Cisco Systems Dell and Hewlett-Packard have perfected the model of outsourcing overseas manufacturing, and benefited from relatively low capital expenditures, even as sales have risen.
The 10 tech companies generating the most cash have amassed fortunes to rival the gross domestic product of some small nations. The total amount of cash and short-term investments on their balance sheets exceeded $222-billion (U.S.) as of their most recently ended reporting periods. Cisco tops the list with almost $40-billion, followed by Microsoft ($36.8-billion) and Google Inc. ($30.1-billion).
The problem? All that cash has generated some big expectations. Frustrated investors want to share in the wealth and worry that the money is not being used properly.
"They're fed up," Mr. Miedler says. "They think [tech firms]should be paying a dividend, buying back more shares or making smart acquisitions. Investors want to see something positive done with the cash."
Mr. Miedler believes many companies will pay heed to investors' demands. "We expect dividends to start rising, giving investors another reason to buy into the sector," he adds.
Traditionally, high-growth tech companies shunned dividends as the mark of an aging, low-opportunity business. Instead, companies such as Cisco, Dell and Apple Inc. attracted investors on the basis of capital appreciation. But some of the largest players are, in fact, slowing with age. Microsoft, for example, grew at an annualized rate of 7 per cent over the past three years, while Intel's revenue actually fell over the same period.
Google and Apple remain the standouts, each expanding at a rate of more than 30 per cent in the same period. Apple chief executive officer Steve Jobs recently told shareholders that he wanted to hold onto the company's cash, saying it provides "tremendous security and flexibility." Dell and eBay Inc. have also resisted initiating dividends.
But some tech companies are now seeing the virtues of either beginning to pay dividends or increasing their current yields. Cisco, a long-time bellwether for the industry, may have opened the floodgates last week by announcing that it will start paying a dividend in its current fiscal year, which ends next July. Analysts expect a modest starting payout, between 1 and 2 per cent, beginning next spring.
Mark Sue, an analyst with RBC Dominion Securities Inc. in New York, says such a rate would place Cisco in the middle of its peer group. "We expect a quarterly payout with the potential of a steady increase on an annual basis," he wrote in a recent report. He rates the stock "outperform" and has a price target of $26.
Microsoft, which began paying a regular dividend six years ago, announced Wednesday that it will raise its payout by 23 per cent, to 64 cents annually, for a yield of 2.5 per cent. Investors reacted by sending the share price down by 3 per cent.
Walter Pritchard, an analyst with Citigroup Global Markets Inc., said the dividend hike came in at the low end of expectations. The company faces bigger issues, including delivering compelling products for new smart phones and computer tablets, he added. Still, he rates Microsoft shares a "buy" and has a price target of $31.
TECHNOLOGY'S BIGGEST HOARDERS OF CASH:
Cisco Systems $39.9-billion
Microsoft Corp. $36.8-billion
Includes cash, near cash items and short-term investments as of each company's latest filing