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Summary:

It says something about the state of the tech industry that one of the biggest stories in the sector this week is that Cisco is paying dividends to investors. Dividends aren’t unheard of in tech; however, Cisco’s news had that tipping-point feeling to it.

Cisco

It says something about the state of the tech industry that one of the biggest stories in the sector this week is that Cisco is paying dividends to investors. They won’t start until next summer, and payments will be equal to one or two percent of the stock’s price. At today’s prices, that’s an annual dividend of 22 or 44 cents a share. Dividends aren’t unheard of in tech. Texas Instruments started paying them way back in 1962, back when the Beatles released their first record. Intel has paid dividends since 1992, and Microsoft has been paying them since 2003.

However, Cisco’s news had that tipping-point feeling to it: Would Silicon Valley — where the rule of thumb had always been high-tech equals low-dividend — start to pay more dividends? Cisco’s news came on the same day that Microsoft said it would increase its dividend from the current 52 cents a year, even if it meant taking on new debt. In other words, Microsoft was willing to pay interest so that it could pay dividends.

That reignited a debate over dividends. Some asked whether it was bad news for investors. Others thought it was a good thing. But it echoed the debate over dividends that has continued for decades. On one hand, shareholders are a company’s owners, so they’re entitled to a portion of the profits. On the other hand, profits are better plowed into creating more profits, which can enrich investors by increasing the stock’s value.

The anti-dividend sentiment prevailed in Silicon Valley simply because, since the late 1970s, tech companies have largely been growth stocks. During the dot-com boom, the notion grew even more deeply entrenched, but as IT spending remains stagnant, the idea of tech dividends suddenly doesn’t seem so absurd. There are a lot of reason why, but two stand out: Tech giants are hoarding cash, and tech giants have very cheap P/E ratios.

Cisco provides an excellent example of both trends. Cisco’s revenue grew 11 percent last year and is expected to maintain that rate this year. Its operating margins are steady around 20 percent. So, while it’s a maturing company, it’s maturing with impressive growth. Yet the price-earnings ratio has been hovering around 16, below the 20.6 ratio for the S&P 500. Other tech giants have been trading cheaply for some time as well, such as Intel, Hewlett-Packard (11) and Microsoft (12).

Meanwhile, these companies have amassed vast piles of cash. Cisco has $40 billion in cash on hand. A 2-percent dividend would cost it about $2.5 billion, or 6 percent of the total. Microsoft has $37 billion. Much of this money is overseas, and subject to currency losses if the dollar gains. The chart from Ycharts shows the different trajectories taken by Cisco’s P/E ratio and its cash on hand.

In the past, tech companies have used cash to expand operations through organic growth or acquisitions, but few want to expand organically when the forecast for IT spending is looking uncertain at best. Some are concerned that cash-fueled M&A activity has been artificially inflating the value of acquired companies; the huge premium paid for 3Par by HP offering is a good example. That creates a nice payout for startup founders, but it doesn’t make investors very happy.

Until tech stock prices start rising again, pressure is likely to continue from investors and analysts on tech companies to offer dividends, and once they start offering dividends, to raise them. Rather than winning praise as a large-cap tech stock offering dividends, Microsoft had been pressured to fatten dividend payments in the months before this week’s announcement.

There will be holdouts, too, such as Apple and Google, with cash hoards of $25 billion and $30 billion, respectively. Google offering a dividend to investors is as likely a scenario (albeit one more pleasant to imagine) as Eric Schmidt performing a strip tease at a shareholder meeting. Google has always made it clear it will shovel profits into more innovation.

However, if enough companies start offering dividends, it will increase pressure on others. One of the benefits of dividends is that it rewards long-term shareholders like company employees who’ve obtained stock through options packages. If they see their peers at a rival company getting a de-facto raise through dividends, they may start to speak up themselves.

  1. Cisco is no longer a growth stock, it is now a mature business – ergo dividends. Doesn’t imply that all the small growth companies will ape it, but probably does put pressure on all the oher big Tech Co’s.

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