Benefiting from the potential of technology
The starting point for many income investors is often yield - a figure based on dividends paid to shareholders.
But did you know that many of the world's tech companies don't pay dividends?
So where does this leave income investors? Do those looking for income have to shun the tech sector completely and miss out on all this value creation?
Or are there ways to generate an income from cutting-edge technology?
We think so.
Tech & dividends – not oil and water
Tech & dividends – not oil and water
Technology and dividends may not be used in the same sentence very often, but this does not mean that there aren’t opportunities for income investors in this fast-growing sector.
Sure, tech companies are notorious for investing a high proportion of their earnings back into the businesses they are operating, rather than distributing cash to shareholders through dividends.
But they do this because the potential growth from their capital expenditure is exciting. What’s more, technology can change quickly, so some companies may choose to retain cash so that they can acquire businesses or invest in disruptive areas.
Not to forget, some tech firms may also be reluctant to pay dividends out of fear of being labelled as ‘post-growth’ – in other words, the perception could be that they are only handing back money to shareholders because they don’t have anything better to do with it.
Balancing growth and yield
Balancing growth and yield
As an equity income strategy, it may come as a surprise that we don’t obsess about yield. Instead, when selecting companies to invest in, we try to strike a healthy balance between growth and yield.
This means that we invest in a range of different companies with varying yields.
Yes, we look for those that pay a high structural dividend yield, even if it comes at a slightly lower growth potential. However, we also look for companies that may have lower yields (like tech), but where the earnings growth is much stronger and, by extension, the prospects for cash-flow expansion and dividend growth.
Indeed, focusing overly on the yield, ignores the significant cumulative dividend income that can be generated from companies that are increasing their dividends over a longer time horizon.
We look for sustainable growth, not the breakneck kind.
This means thinking extra hard about all the things that could go wrong, and thus jeopardise a company’s ability to pay a dividend. In this respect it is worth noting that tech companies often pass our credit analysis and stress tests with flying colours, in no small measure due to their net cash positions and high free cash flow generation.
Mature doesn’t have to mean dull…
…it can mean rich
Mature doesn’t have to mean dull – it can mean rich
There’s a common view that to get exposure to the white-hot trends in technology, investors need to go for younger and risky ‘start-up’ companies that are investing aggressively, and as a result not paying a penny to shareholders.
This is not the reality we observe.
Securities Trust of Scotland invests in a number of companies that are at the cutting edge of technology and innovation, but still pay out a dividend to investors. In fact, many of the world’s largest tech firms are leading the innovation race in sectors like autonomous driving, intelligent infrastructure, FinTech, the internet of things or mobile technology.
A key differentiator, in our opinion, for these more established companies is very strong cash balances, which they can pay back to investors through dividends or buybacks, or use to invest.
Take a high-profile company like Apple (held by the Trust), which sits on a veritable tower of cash – US$145 billion after debt has been deducted*. Whichever way you look at it, this creates significant safety and flexibility, whereas younger tech firms tend to burn through cash, and could be at the mercy of borrowing conditions and general risk appetite.
*Source: Apple. As at 31 March 2018.
When is a tech company not a tech company?
Of course, technology is increasingly ubiquitous, so innovation and disruption can feature in companies that don’t strictly fall into the ‘tech’ category.
Examples from the portfolio include:
- Schneider Electric, which is making real inroads into producing market-leading products to enable your home to be driven by digital devices, but is categorised as an industrial stock, not a technology company.
- Continental AG, the automotive manufacturing firm, which has thousands of employees working on market-leading innovation in areas that include electric mobility, automated cars, in-car infotainment and driving safety, all of which require huge computing capacity.
- Transurban, an operator of toll roads, has invested in advanced systems and technologies to manage its assets, including 3D video systems on their tolling gantries, as well as trialling connected and automated vehicles (CAVs) on their roads.
Please be aware that the information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the securities discussed here were, or will prove to be, profitable.
CASE STUDY: MICROSOFT
Still at the cutting edge
Microsoft: still at the cutting edge
While many may perceive Microsoft as a ‘legacy’ tech business, it’s a market leader in several important emerging tech trends including, cloud computing, machine learning, artificial intelligence, augmented reality and ‘quantum computing’.
This shifting focus is reflected in the fact that one of the company’s most well-known software products – Office – now generates more revenues from Office 365, its cloud-based subscription version, than from traditional Office software licenses.
From a growth perspective, Microsoft’s early transition to the cloud looks to be paying off and consequently the company offers the income investor access to one of the fastest-growing areas of technology.
The UK is technology light
The UK is technology light
Try to think of a major listed UK tech name? It is not easy – for a simple reason.
Not only does the UK stock market exhibit high concentration from an income perspective (a small number of companies paying the lion’s share of dividends) but also in terms of sector, with financials, oil& gas, and consumer staples representing over 50% of local indices such as the FTSE All Share.
By contrast, technology’s weighting is only around 1% (a fraction of the nearly 20% weighting in global indices such as the MSCI ACWI). In other words, to seize the best opportunities in this area, investors need to venture beyond UK shores.
Rethinking tech and income
Rethinking tech and income
Many traditional income strategies tend to screen out tech companies because of a strict focus on yield.
We believe this overlooks the growth potential and attendant dividend expansion offered by some companies in the sector. We see very attractive long-term trends and improved competitive dynamics for many tech companies, which boast robust fundamentals thanks to strong free cash flow margins and low balance-sheet risks.
What’s more, we look to leverage the growth potential from technology in a range of companies that may not be immediately associated with cutting-edge innovation.
Finally, and importantly, we do this by casting the net wide as the best tech opportunities are scattered across the globe.
Securities Trust of Scotland
The global equity income trust
Securities Trust of Scotland is an investment trust that aims to deliver a rising income and long-term capital growth from a portfolio of global equities.
So, if you are looking for income and growth potential – the best of both worlds – Securities Trust of Scotland may be worthy of consideration.
The company benefits from a global investment remit. This provides the widest opportunity and the freedom to invest in some of the world's best companies, irrespective of location.
Also, the inherent diversification offered by global products means that they are often referred to as 'one stop shop' portfolios and are used as a core holding, supplemented by other niche or regional products.
Led by Portfolio Manager, Mark Whitehead, a global equity income specialist, shareholders can rest assured that every stock in the portfolio has been thoroughly researched by a team of skilled investment analysts, and then hand-picked on the basis of their individual characteristics and potential to perform in all market conditions.
It is available for your ISA, SIPP or as a stand alone investment.
Past performance is not a guide to future returns.
This information is issued and approved by Martin Currie Investment Management Limited. It does not constitute investment advice or represent an inducement to invest. Market and currency movements may cause the capital value of shares, and the income from them, to fall as well as rise and you may get back less than you invested.
Please note that, as the shares in investment trusts are traded on a stockmarket, the share price will fluctuate in accordance with supply and demand and may not reflect the value of underlying net asset value of the shares.
Depending on market conditions and market sentiment, the spread between purchase and sale price can be wide. As with all stock exchange investments the value of investment trust share purchases will immediately fall by the difference between the buying and selling prices, the bid-offer spread.
The value of investments and the income from them may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. Investing in foreign markets introduces a risk where adverse movements in currency exchange rates could result in a decrease in the value of your investment.
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The information contained in this document has been compiled with considerable care to ensure its accuracy. But no representation or warranty, express or implied, is made to its accuracy or completeness. Martin Currie has procured any research or analysis contained in this document for its own use. It is provided only incidentally, and any opinions expressed are subject to change without notice.
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