Can big tech become a new source of income?

Meta is the latest US technology mega-cap to have provided the stock market with cause for cheer. Not only did its quarterly revenues, earnings and growth outlook surpass expectations, the company surprised investors by announcing it is joining the ranks of American dividend payers. Meta shares leapt more than 20% after the announcement.

The reward for waiting – which is often how dividends are viewed – will be small. Fifty cents per quarter from a share trading at around $470 will hardly make any difference to investors’ overall returns. The dividend will be substantially less than a daily swing in the company’s share price. 

The preferred route to returning money to shareholders in the US is via share buybacks. Dividends are considered an old-fashioned way of doing a similar thing. Even today with America home to a large number of successful, mature businesses, the S&P 500 Index is expected to yield just shy of 1.5% this year¹. 

Even so, there is a kind of logic to the move. At minimal cost, Meta is sending a subliminal message to shareholders that it’s going to be around for a while. It’s also saying that investors can probably bank on some kind of return, even as its shares travel a rocky road, hopefully to even greater riches.  

Dividend payouts tend to be far less volatile than share prices, and an income stream from shares provides at least a psychological boost on the journey that investors embark on when they buy shares. 

In Britain, dividends have been and remain a great source of returns. Since the beginning of this century, the FTSE 100 Index has risen by just 10%. However, the iShares Core FTSE 100 ETF – a tracker fund launched in April 2000 that includes reinvested dividends – is up 168%².  

While the US is very unlikely to mimic the UK in this respect in the foreseeable future, there is a strong investing cohort that fully appreciates the benefits of dividends.   

Magnificent 7 dominate the tech revolution spoils

The Magnificent 7 stocks that have just played a large part in driving the S&P 500 up to the 5,000 milestone this month are: Google’s parent company Alphabet; Amazon; Apple; Facebook’s parent Meta Platforms; Microsoft; Nvidia; and Tesla. Most investors have stakes in them, either through personal investments, tracker funds or pension schemes.  

My colleague, Nafeesa Zaman wrote a great article about the Magnificent 7 stocks and why they are trending.

This century, they have grown to become seven of the world’s largest ten listed companies. Only the corporate giants Saudi Aramco, Berkshire Hathaway and Eli Lilly have managed to keep pace.  

In terms of business idea, the Mag7 are a diverse bunch. What sets them apart from less successful competitors, however, is the ability to select and adapt a business model and execute it better than anyone else. 

The income you might receive from the Magnificent 7

If you take the four Mag7 companies that now pay dividends, you get a simple average yield of 0.43%. That’s not much, even compared to the low yield currently available from US shares overall. While these dividends should grow over time, they’re unlikely to make up a significant proportion of investors’ overall returns in the near term.
 

While the remaining Mag7 companies could easily pay dividends, Amazon and Tesla have both ruled it out for the foreseeable future. They intend to retain all earnings to finance future growth. Alphabet has been far less categorical on the matter. 

The value conundrum

Investors have always had trouble placing a fair value on tech stocks. Valuations fluctuate and when they get out of line the goalposts tend to get changed. High valuations beget more talk of the rationalities of paying up for innovation and repeatable growth way out into the future.    

The trouble today is that momentum is the only game in town. America’s mega-cap tech stocks sped higher in 2023, while the rest of the US stock market bumped along the bottom. India’s stock market went up (almost) in a straight line, while most other emerging markets didn’t even make it onto investors’ radars. While that’s happening, value indicators have less merit. Until, of course, something upsets the party and then they’re tremendously important once again. 

So are dividends good or bad?

Traditionally, ex-growth companies paid dividends. Sustained high dividends generally meant that a company had reached the stage where shareholder loyalty was considered more important than reinvesting all profits back into a business.  

There’s still a sense of that these days, which is why Meta’s inaugural dividend may have raised a few eyebrows. On the basis of the company’s own growth outlook, the mature business argument doesn’t apply. But it might in the future. 

Apple’s growing dividends have confused some investors, certainly. In the past there has been talk of Apple turning into an income-growth stock as it matures. That’s overdone for sure, bearing in mind its 0.5% yield. In any case, a good total return is what counts, and if that can be achieved with a bit less risk than before, that’s all to the good.  

However, dividend payments can still sit uneasily with investors seeking the strongest possible capital returns. If a business is expected to grow quickly, why not put as much as you can back into it?  

The answer is these companies are throwing off so much cash, it’s become hard to reinvest it all to produce more growth. Paying a dividend puts some of that cash to work by reinforcing shareholder loyalty. 

What about growth?

Growth is the main reason why investors buy tech stocks. Judging by the latest clutch of quarterly results from the Mag7, the tech train is on track. Besides Meta’s strong results and dividend event, investors have had other positive news to relish.  

Amazon also beat expectations for the quarter and issued strong forward guidance. Microsoft did much the same owing to further progress in AI and its Azure cloud computing business. Meanwhile Apple’s revenues returned to growth after successive quarterly declines last year, as iPhone sales stayed strong.   

News like this helps keep the Mag7 firmly into the growth stock category, with dividends likely to remain in a poor second place in these companies’ priorities. 

How to invest

It’s easy to forget the Mag7 performed horribly in 2022. Moreover, it took until the final quarter of 2023 for them to press home an advantage. It remains as true today as ever before that tech investing can involve some considerable nail-biting over shorter time frames. 

Such volatility can be turned to your advantage by investing in a tech heavy fund via a regular savings plan. Volatile assets lend themselves to such schemes, because they automatically tend to increase the number of opportunities to buy more shares at low prices and fewer at high prices. Automation is the hallmark of regular saving, which avoids the pitfalls of trying to pre-empt short-term movements in markets and shares.    

Another way to smoother returns is an actively managed fund with an exposure to technology but other stocks besides. Not only does that lessen the chance of being too wedded to one sector when sentiment turns against it, it means you are invested in a fund that can dynamically adjust its tech exposure up or down as conditions change.   

Fidelity’s Select 50 list contains highly respected funds that offer investors significant stakes in the technology sector in the context of a wider global portfolio.  

The £3.6 billion Rathbone Global Opportunities Fund is a famous proponent of large tech companies that, since the pandemic, has taken on a more diversified exposure to world markets. The fund’s technology exposure has almost halved, to around 16% as at the end of December.³ However, star performer in 2023 Nvidia is the current top holding, with Microsoft in second place and Alphabet in eighth. 

Meanwhile, for those that prefer a low-cost, passively managed option, you’ll find all of the Mag7 stocks within the top 10 largest holdings of the Legal & General Global Equity Index Fund. This fund is also one of Tom Stevenson’s fund picks for 2024. 

Source:

¹ Wall Street Journal, 02.02.24 

² London Stock Exchange and BlackRock, 05.02.24 

³ Rathbones, 31.12.23

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.