First Trust: Income from technology

by Mark Salzinger, editor The Investor's ETF Report

In recent years, technology stocks have exhibited some of the fastest dividend growth rates in the market, and some tech bellwethers now offer investors robust yields 50% to 100% higher than the S&P500.

This month we examine a new ETF, First Trust NASDAQ Technology Dividend (TDIV), as we consider the total-return prospects of dividend-paying technology stocks and their potential role in your portfolio.

There are two operational reasons that technology companies have increased their dividend payouts.

One, established tech companies tend to be exceptionally profitable. Two, technology companies with strong competitive positions don’t have to reinvest as vigorously to maintain their advantages as they did when they were smaller companies.

Over the five-year period ending Aug. 31, 2012, technology-stock dividends have grown at an annualized rate of 18.8%, vs. 1.6% for the S&P500, according to First Trust.

Technology-stock dividends even increased in 2008 and 2009, when dividends declined for the S&P500.

The stocks in the First Trust ETF generate copious free cash flow (cash from operations minus capital expenditures, which can be used to invest in the business, pay down debt or increase dividends), resulting in an 8.9% free-cash-flow yield (free cash flow as a percentage of market value), according to First Trust.

So, the ETF’s average stock has plenty of headroom for further dividend growth. Also, it trades at a moderate valuation, with a price/earnings (P/E) ratio of 12.6.

TDIV invests in technology stocks that have paid a dividend within the past 12 months and have a yield of at least 0.5%.

About 20% of its portfolio is dedicated to telecommunications stocks, so giants like Verizon and AT&T are included. Semiconductor and semiconductor-equipment makers make up 25% of the portfolio, with nearly one-third of that position which in Intel.

TDIV has limited exposure to slower-growing computer-and-hardware companies (about 7%). Software accounts for about 20% of the portfolio.

The ETF levies a 0.50% expense ratio. Its underlying index yields about 3.1%, so over the course of a year investors can reasonably expect around 2.6% after subtracting the expenses. That’s more than 25% more than the S&P500 (2.0%).

However, we think the most compelling reason to own these stocks is not their current income but their potential for long-term profitability, dividend growth and mild valuation.

TDIV’s P/E of 12.6 is appealing relative to other dividend-oriented sector ETFs. Of course, as with any new ETF, use limit orders instead of market orders to buy and sell shares.

Learn more about this financial newsletter at Mark Salzinger's The Investor's ETF Report.

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