Dividend growth and earnings growth are among the most desired characteristics of any equity investment, with balance sheet strength rounding out the top three criteria for most portfolio managers, and certainly for me. In a low yield, slow growth environment, companies that have a strong balance sheet are growing their revenues and earnings, and companies that consistently raise their dividends should significantly outperform other companies – which is why I am raising my exposure to large and mid-cap technology firms.
Technology firms still have the reputation of being aggressive and risky, when in fact the opposite is often true. First is the valuation – the forward price earnings ratio of the S&P (^GSPC) technology sector stands at 12.2x as of December 31, 2012, compared to a 15-year average of 23.8x.
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For those of you who believe that forward estimates are too aggressive, the trailing PE (based on what these companies have already earned) is 14.6x, compared to a 15-year average of 26.7x. Further, the dividend yield for the sector stands at 1.7% compared to an average yield of 0.6% over the past decade and a half.
But wait, there's more. According to a report from Standard & Poor's, the companies within the technology sector are paying more dividends than companies of any other sector – now accounting for 14.7% of all dividends paid by S&P 500 companies. That's up from just 6% in 2007.
The growth rate for the sector is significant as well, outpacing expectations for consumer staples, financials, and utilities, which are the sectors that are traditionally associated with low valuations and attractive dividends. The technology sector as a whole has a consensus earnings growth rate over the next five years of 15.8%, compared to a meager 5.5% for the S&P 500 as a whole.
Balance sheets of many of these companies are fortresses – just take a look at Apple (AAPL), which is expected to have as much as $200 billion in cash and equivalents on its balance sheet by the end of 2013. International Business Machines (IBM) has over $70 billion in retained earnings and nearly $13 billion in cash on hand. A lesser-known and smaller technology company, Cognizant Technology Solutions (CTSH), which provides IT consulting and outsourcing services, has no debt, and over $2 billion in cash and equivalents on hand (CTSH does not pay a dividend – yet).
Looking ahead into 2013 and beyond, I accept many central banks' view that the world is likely to remain in a slow growth environment for several more years. This hypothesis is clearly reflected in the earnings per share growth expectations for the S&P 500. At the same time, I believe inflation will creep up as the impact of all of the dollar, yen, and euro printing ultimately drives prices higher. So, I want to invest in companies I believe will grow more rapidly than the average, pay a higher dividend than the average, and have a strong enough balance sheet to weather any storms that might lie ahead.
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Some of my favorites, all of which are held by the GMG Defensive Beta Fund (MPDAX), include Intel (INTC), IBM, Microsoft (MSFT), Cognizant Technology Solutions, Apple, Oracle (ORCL), Cisco (CSCO), and Adobe Systems (ADBE). You will note that several of these don't pay dividends (yet); I expect that many of them will within a year or so.