“KLA is another example of a relatively ‘boring’ company that offers exciting return prospects. At the time of purchase in October 2016, it offered many of the characteristics that we look for in a stock – an attractive valuation, a healthy balance sheet with strong cash conversion and an excellent track record of capital allocation.”
Like Microsoft, Roberts says the strength of KLA’s underlying business means it is well positioned to sustainably grow both its earnings and dividend payments to shareholders over time.
It isn’t only Fidelity that is sold on the US tech sector being a source of income opportunities. Microsoft and Apple are two largest holdings in George Boyd-Bowman’s Neptune US Income Fund. Overall, the IT sector makes up 18.3% of the fund’s portfolio.
“The technology sector in the US houses a whole plethora of companies that have, at least, two characteristics that should get income investors’ juices flowing – the combination of structural growth opportunities and high margin cash generative business models,” says Boyd-Bowman.
“This combination, in our experience, tends to lead to an extended period of above average dividend growth. The tech sector has a CFO yield (cash flow from operations as % of sales) of 27.7%, almost double that of the wider S&P 500 with 15.7%, and capital allocation discipline sets the stage for healthy and growing dividend yields.”
One company Boyd-Bowman picks out is the semiconductor manufacturer Texas Instruments, which he says has arguably set the standard for its technology peers to aim at.
“Their competitive advantages have led to exceptional market shares in turn affording them almost 50% operating margins,” he says.
“When you combine this with balanced capital allocation, over the last 10 years they’ve returned $9bn via dividends but at the same time re-investing $32bn back into the business, you can generate exceptional dividend growth – in Texas’ case at a 29% compound annual rate over the last 10 years.
“Fellow technology companies are learning that by paying attractive dividends you will, in Texas’ words, appeal to a broader set of investors.’ This is causing other companies to follow suit.”
Another factor which could lead tech to become increasingly attractive to income investors, adds Boyd-Bowman, is the huge cash piles many of the companies have been building up. It is estimated US companies now have more than $3trn, or roughly 13%, of the country’s GDP stashed off-shore.
Boyd-Bowman says that tech companies play a big part in this, with the five largest overseas cash piles belonging to Apple, Microsoft, Cisco, Google and Oracle. Apple, alone, has over $250bn.
“This cash is seen as ‘trapped’ because it would be liable to be taxed at 35% should it be brought home,” he says. “However, despite Trump reform expectations reaching rock bottom, we believe there is still a decent chance that a tax repatriation deal is done over the next year or so. The last time this happened in 2004, at a tax rate of just 5.25%, almost 75% of the money stored overseas made its way back to the US.
“Should we see a repeat of a repatriation tax holiday this is a massive boon to income investors. What will happen with this money? Well, some of the cash will rightly be re-invested into business, some might also be used to conduct M&A, but crucially it will also enhance shareholder returns and boost both buybacks and dividends.”
