Tech companies such as Facebook, Netflix, Amazon.com and Alphabet (also known as FANG) have ballooned in value in recent times and are now locked in a race to become the world’s next trillion-dollar firm.
Despite their dizzying rise in value, none of these fabled tech firms pay dividends, putting them at odds with giants in other industries like consumer staples, industrials and retail.
However, the relative absence of dividend payments is actually in line with a tradition of many tech companies not being considered income vehicles, and therefore not paying dividends.
To understand why some tech companies generally shy away from paying dividends, it’s important to start with the basics.
What are dividends and why do investors like them?
Simply put, dividends represent profit made by companies which are then distributed to shareholders. You can think of it as the money you earn from owning the shares of a particular company.
So, in practice, say shares in a company were bought at $1.00 each and a dividend of 5 cents per share was paid every year, then you would see a 5 per cent return (excluding any changes to the share price).
How you get dividends is that firms consult their books, take their financial pulse, and then determine whether it's better to pay some profits to shareholders as dividends, reinvest in the business, or buy back stock.
The advantage of dividend-paying shares is that they deliver a source of income and, if the share price goes up, may provide capital gains when held for a certain period of time.
In today’s low interest-rate environment, dividend-paying shares can be a preferable form of income for investors compared to term deposit or government issued bonds.
In Australia, unlike many other jurisdictions, there’s the added advantage that companies can attach to their dividends “franking credits” -- a type of tax break that that saves investors from having their dividends double-taxed as is the case in many other countries.
So what’s the deal with tech companies?
Thing is, many tech companies generally see paying dividends as a sign that the exciting growth phases of their businesses are drawing to a close, or indeed finished.
Put another way, tech firms tend to believe their profits can be better used to fund growth objectives. And dividends should only be paid when no other rational uses exist.
Remember, paying dividends is only one of the ways that companies can decide to use profits and for companies that are still growing rapidly, like many tech start-ups, it generally makes more sense to invest as much as possible into future growth.
That’s why dividends tend to be more associated with mature sectors like healthcare and industrials, and established stocks, think Coca Cola Co and Exxon Mobil Corp, than in tech.
In the tech world even established firms like the FANGS believe they can do a better job of increasing their value, and share price, by reinvesting earnings than by paying dividends.
One big reason is tech firms generally need to fund acquisitions and often look to keep growth firing by snapping up the best and brightest new innovations. Notable examples include Facebook’s 2014 acquisition of messaging app WhatsApp, Apple’s 2018 acquisition of Shazam and Beats in 2014 and Google acquiring Nest Labs in the same year.
It’s of course also handy for a company to have cash on hand in case it hits trouble or if it needs to make rapid changes in line with shifts in the industry, which can occur very fast in the technology field relative to other, safer, sectors like industrials or utilities.
What does the future hold?
While historically many tech companies have rarely paid dividends, many large and very successful companies in the sector have, over time, come to pay substantial dividends to shareholders.
Examples include Apple, the world's most valuable tech firm by market cap, and software giant Microsoft that started paying dividends all the way back in 2003.
Other notable income generating tech stocks include Cisco, the largest manufacturer of network routers and switches in the world, tech legend IBM, mobile chipmaker Qualcomm, and hard disk drives manufacturer Seagate.
There have also been recent calls for Facebook to pay dividends due to the social media giant “pushing up against the limits of growth”, but this has yet to materialise.