Dividends and tech companies can never seem to be mentioned in the same breath. High-tech, silicon valley juggernauts are focused, almost exclusively, on growth. Innovative firms operate in rather risky markets with intense competition. To top it off, a lot of these tech companies give away their services for free.
But that hasn’t kept them from being profitable. Just last year, the five most valuable companies in the world were all in the technology industry. At $571B market capitalization Apple is the largest, followed by Alphabet (Google) at $540B and Microsoft at $441B. Amazon at $364B, and Facebook at $357B complete the list of most valuable firms on the planet.
Yet, from that list of extremely valuable tech firms, only two actually pay a dividend. The apple dividend is, obviously, larger but at 2.5% Microsoft isn’t too far behind.
But why do the other tech companies shy away from dividend?
The apple dividend wouldn’t have been this surprising if it this were 1950. Back in the mid-20th century most stocks paid a dividend to the shareholders. The biggest companies, in fact, were nearly obligated to do so. A company that didn’t pay a dividend was seen as weak.
Most investors, including legendary value investor Benjamin Graham, believed a dollar in dividends was worth more than a dollar in earnings. Earnings, they argued, could be fabricated or inflated. Dividends, meanwhile, was hard cash that turned up regularly in the bank account.
Benjamin Graham said that two-thirds to three-fourths of earnings should be paid out by a company in dividends. It was seen as the only way for investors to get the value they deserved for their patience.
However, two technology-focused companies changed this perception – International Business Machines Corporation (IBM) and Texas Instruments.
Both companies were growing relentlessly fast in the 1960’s. The pace of growth was so fast, investors shunned dividends. Instead, these companies kept piling money back into the venture to fuel their extraordinary growth rate. Investors, meanwhile, were willing to accept this lack of payment because the stock was on a tear. The companies showed tremendous results every year and the phenomenal growth rate compensated investors for their lack of cash dividends.
Before long speculators and growth-oriented buyers had pushed the stock so high it didn’t seem a dividend was necessary to attract investors anymore.
That tradition is still preserved by modern tech companies. Companies like Tesla (TSLA) can’t afford to pay a dividend because it’s burning through cash aggressively. That’s also the case with recently IPO’d Snapchat (SNAP). SNAP is worth a whopping $34 billion despite making no money at all.
This isn’t necessarily wrong. Tech companies tend to follow an aggressive growth strategy. If you want to expand the business and push out all the competitors in a ‘winner-takes-all’ industry, you have to be willing to sustain losses for incredibly long.
Companies like Google and Facebook make a healthy profit, but there’s another reason they don’t pay dividends – opportunity.
The tech industry is rife with high-potential targets that can be snapped up for a breathtaking price tag. Facebook, for example, paid a jaw-dropping $19.6 billion takeover messaging app Whatsapp in 2013. Google bought Nest Labs and Apple bought Beats headphones. In the tech industry buying out high-profile targets is common. It is seen as a clever way to keep growing and stay relevant. However, these high-profile targets don’t come easy. The higher price tag makes it necessary for mature tech firms, like Google and Facebook, to hoard cash.
These tech giants need to save all the cash they can get their hands on to buy up smaller firms with massive potential later. Investors, meanwhile, are compensated by the higher rate of capital gains if these acquisitions pan out.
Finally, there’s Amazon’s reason for not paying a dividend – reinvestment. Amazon has been making substantial losses for many years, but its core operations are profitable. Amazon tends to take the operating profits and reinvest it in other industries and more expansion.
This has helped Amazon grow significantly over the years. Amazon has been expanding, vertically and horizontally, for decades. This has left it with a substantial market share in each industry it has entered over that period.
While the company may be a long way off from an apple dividend type policy or even a reasonable profit, shareholders seem willing to be patient as the stock climbs higher.
Tech companies have unique products, surrounded by unique business models. Many of these companies are built with disruption and innovation in mind. Disruption, innovation, and aggressive growth are expensive, which is why most tech companies shun dividends in their initial years.
Market forces may compel huge tech firms to declare dividends later. When the market is saturated and there’s no room left to grow, companies give into the pressure from investors and start returning their humongous cash piles. Apple, IBM, and Microsoft are the best examples of this.
These stocks may not fit your dividend portfolio, but that doesn’t make them bad investments.