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Tech companies told to pay dividends.

ML analysts calculated that barely 8% of US high-tech companies pay dividends, whereas 50% of non-tech companies do so. The difference in dividend policy between tech and non-tech companies not only raises questions about why companies pay dividends in the first place, but is resulting in pressure for some cash-rich tech companies to start making distributions to shareholders as growth slows.

Chief amongst these is Microsoft, which has a market value of almost $350bn and $36bn in cash. “We think Microsoft and others should follow IBM’s lead and return money to shareholders when returns in excess of the cost of capital can’t be achieved,” say analysts Steve Milunovich and Zhen-Hong Fan in a circular*. “Managements will worry about the signalling effect of lower growth, but the fact is these large tech vendors are maturing.”

Merrills spoke with a number of technology companies about why they don’t pay dividends and found several explanations:

– Share re-purchases were said by some to be a more efficient way to return cash to investors.

– Companies would rather invest in R&D, especially since investors buy tech stocks for growth.

– Cash is needed for acquisitions and to survive downturns.

Tech companies in favour of paying dividends argued that investors often knew better how to allocate funds and that, with interest rates low, if companies can’t find investment opportunities then it’s better to return the cash to investors than have it sit in a bank. Investing in projects that exceed the cost of capital may reduce ROE, but would increase economic value added (EVA).

The “growth” argument for not paying dividends may be attractive, but the analysts also found that S&P500 Tech stocks had exactly the same median growth rate, 20%, as S&P500 Non-Tech Growth stocks.

Instead, they concluded there are two reasons why tech companies typically don’t pay dividends: investor greed and company fear. They argue that many investors have “invest in the next Microsoft” hopes when it comes to tech stocks, a theory which also explains why tech stocks are more highly-valued than non-tech stocks with similar growth rates. “It is certainly possible that investors overestimate tech companies’ ability to grow and prefer that companies invest the cash,” say Milunovich and Fan.

On the corporate side, they believe tech companies are afraid that starting a dividend programme would signal that the company’s growth has slowed, depressing the earnings multiple.

The analysts believe that Cisco and Oracle should also start paying dividends, as Intel did in 1992 to attract pension funds that were barred from investing in nil-distribution companies. “Managements sometimes do foolish things with excess liquidity,” they say.

* Tech-Strat Barometer: Should Tech Companies Pay Dividends?

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