Invest in tech giants for their dividends. I'm serious.
Over the past year, stocks of big tech companies have dominated price-to-earnings ratios. That's great, but big gains always lead to investor uncertainty about whether they can continue. While sales and earnings growth may already be priced into current valuations, dividend growth may not. And growing dividends could keep investors happy for years to come.
$1 trillion stock Microsoft
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apple
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Amazon
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alphabet
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Meta Platform
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NVIDIA accounts for nearly half of that $9 trillion-plus profit.
S&P 500
Over the past 12 months, the six companies have risen an average of 66%, with all but Apple outperforming the broader market.
However, the group's shares are priced at an impressive 32 times projected 2024 earnings, 45% higher than the market average of 22 times.
Of course, there's good reason for this: Wall Street expects these stocks' earnings to grow about 25% on average over the next few years, roughly double the rate of the broader S&P 500. Faster growth should translate into higher valuation multiples, which in turn should translate into above-average dividend growth.
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Increasing dividends alone are enough to justify a higher stock price for patient investors. Take Microsoft for example. If the company grows and pays out cash flow like a typical company in 10 years, shareholders could get dividends of about $4 per quarter, up from 75 cents today. That's an average growth rate of 18%. Assuming current market dividend yields remain constant, a $16 annual dividend means the stock price would be about $1,100. The current stock price is about $430.
A lot will change over the next decade, but it shows the power of growing dividends. The same math applies to four out of six stocks. Amazon doesn't pay a dividend, but it should. Nvidia pays a tiny dividend.
The artificial intelligence darling recently raised its dividend by 150%, which is great, but the increase was only to ensure that the quarterly dividend would be 1 cent after a 10-for-1 stock split. Nvidia stock currently yields about 0.04%, the lowest among dividend-paying stocks in the S&P 500 index. For now, Nvidia stock will continue to be driven largely by the growth of AI computing, not by dividend growth.
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That shouldn't be the case for Amazon. It's time to start paying a sizable quarterly dividend, as Meta and Alphabet did this year. For the e-commerce and cloud giant, such a yield would translate to a quarterly dividend of 20 or 25 cents, eating up about 14% of its projected free cash flow for 2024. That's a safe payout rate. Dividend payers in the S&P 500 spent about 43% of their free cash flow on dividends over the past year.
That could be a catalyst for a rise in the stock price. To be sure, a dividend initiation doesn't necessarily work that way, says Chris Senyek, a strategist at Wolfe Research. “The outcome will ultimately depend on whether the market views the announcement as a turnaround in capital allocation or as signaling the end of secular growth,” he wrote in a recent report.
Investors have classified Meta and Alphabet's dividends in the “aggressive capital allocation” category. Meta's shares have risen about 21% since it declared its first dividend on Feb. 1, outperforming the S&P 500 by about 14%. Alphabet's shares have risen about 13% since it declared its first dividend on April 25, outperforming the S&P 500 by about 9%.
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Meta and Alphabet's dividends don't come at the expense of growth: Wall Street still expects earnings growth of about 20% per year on average over the next few years, which would be on par with or better than what both companies have delivered over the past few years.
High valuations are always a concern for investors, and increasing cash flows and dividends could help.
Write Al Root (allen.root@dowjones.com)
