Sunday, August 18

Week 111 - Information Tech & Communication Services Stocks with Dividend Growth

Situation: When a country is digging itself out of recession, industries recover in a predictable pattern. Corporations start spending more on capital equipment upgrades (infrastructure, computers, software, ships, planes, locomotives, rail cars, pipelines) while avoiding new hires as long as possible. Then new hiring takes place followed almost immediately by an uptick in consumer discretionary spending (autos, housing, appliances, restaurants, etc.). Since the economic future appears brighter to the consumer (ie., workers), much of this spending is financed by credit, allowing interest rates to rise and banks to recover. The increased profits that start with “consumer discretionary spending” finally affect the financial, communication services, and information technology industries. Those industries suffered the most during the recession but now start to exhibit strong growth that eclipses defensive industries like healthcare, utilities, and consumer staples, including food.

Painful as it is, investors need to dollar-average some money into technology stocks throughout the recession and recovery periods. This is best done with a balanced index fund where 40% exposure to bonds hedges the volatility of such growth stocks (see VBINX in the Table). For you investors who want to try your stock-picking skills on growth companies, look for those that not only pay dividends but those whose managers try to hold onto long-term investors by growing dividends even during recessions. That’s a unique feature of American capitalism. (In other countries, dividends are paid in proportion to Free Cash Flow). There aren’t very many technology companies with such a record of relative stability, and a lot of those are small or medium-sized companies that have carved out a niche based on patents: only 9 of the 19 companies in the Table are in the S&P 500 Index.

For this week’s blog, we’ve looked at computer technology companies that have managed to increase their dividend annually for the last 10 or more yrs. Verizon Communications and Accenture have been added because those are large information technology companies that are within 3 yrs of being counted among such “Dividend Achievers.” That is Standard & Poor’s name for companies that have increased dividends annually for the past 10 or more yrs. There are 201 such companies; the full list can be found at the website for the Exchange-Traded Fund (PFM) that owns a capitalization-weighted amount of shares in all 201 stocks. For companies that perform less well than VBINX on a particular metric, we’ve highlighted that metric in red. Since we’re confining our attention to companies in the most competitive of industries, there are many red highlights. Nonetheless, we find 4 companies that are:

   a) large enough to be in the S&P 500 Index, and
   b) perform about as well or better than VBINX on a long-term, risk-adjusted basis (Column E).

Those 4 are: International Business Machines (IBM), Accenture (ACN), Automatic Data Processing (ADP), and Verizon Communications (VZ). To evaluate recent finance value, we look to the Barron’s 500 table published each year in May, where companies are ranked with respect to cash flow and sales trends over the most recent 1 & 3 yr periods. We’re particularly interested in companies that improved their 2012 rank over their 2011 rank (Columns J & K). Accenture (ACN) and Verizon Communications (VZ) are among those, and therefore have both long-term and recent Finance Value. You’ll need to dig deeper before deciding whether or not you’d like to start a dividend reinvestment plan (DRIP) in either company.

Bottom Line: Stock-picking is hardest for computer technology companies, but those companies are central to the Information Revolution that has eclipsed the Industrial Revolution. Trouble is, information technology changes so rapidly that even the strongest companies can fall by the wayside. But the biggest of them usually recover to some extent, since their core technologies are both patented and essential to industry-wide standards that underpin the Information Revolution. Nonetheless, their investors can become disappointed for long periods, and will often decide to sell at a loss rather than support a charity. The good news is that companies recognize these concerns and have developed dividend policies that are more shareholder friendly. Intel (INTC) and Microsoft (MSFT) are instructive examples; International Business Machines (IBM) also stumbled but then moved quickly to redirect its business plan to one that supports stable growth. 

Risk Rating: 8

Full Disclosure: I have stock in IBM, INTC, ACN, and MSFT.

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