Cash on the balance sheet, record earnings, and strong sales growth – three components that you would normally associate with a dividend paying stock. Well not in Silicon Valley! At least not in the smaller end of town. Venture Capitalist Richard Harroch once said “It’s almost always harder to raise capital than you thought it would be, and it always takes longer. So plan for that.” This quote goes a long way in highlighting why Silicon Valley has such an issue with dividends.
The start-up mentality is probably the most definitive reason why publically traded tech companies will not distribute earnings to their shareholders. Tech start-ups will traditionally go through four distinct phases in their lifecycle – Idea, Creation, Funding and Listing. It can be both a lengthy and difficult process due to competition, and lack of funding. Hearing about the successes of the Apple’s of the world almost clouds our judgement, and as investors of smaller tech we question why these companies that have so much cash on their books do not wish to share the love – so to speak.
The start-up mentality in its simplest form, is almost borne out of necessity. Management have had to manage their finances with such precision during the early days that they now find the distribution or dividend process almost foreign.
Research & Development Costs
Shifting trends in innovation mean higher research and development costs. According to San Jose Mercury News, Google now has the second highest R&D program behind Intel, with Facebook in 8th, and EBay in 9th position. As new tech is more focused on social networking, search and internet related activities, keeping up to date and abreast of new trends is critical. This comes with costs and may factor into the reasoning behind why new tech will not pay out a dividend.
Growing inorganically is a strategy that has gained significant traction in the last 5 years. Facebook’s board can certainly attest to this fact, with 40 purchases since 2005. The most well-known being that of Instagram and the messaging service WhatsApp. Paying out dividends reduces cash reserves and the opportunity to capitalize on new and exciting opportunities.
The final and somewhat definitive reason as to why new tech does not implement a dividend pay-out strategy, comes down to earnings growth. Start-ups will traditionally be valued on a per user or reach basis, rather than based on revenues and profits. This means it can be difficult to understand the true cash flow basis of a tech company.
- The Information Technology sector has risen 9.65% in 2015 versus 7.04% for the S&P500. This puts it behind 4 other sectors including Healthcare, Consumer Discretionary, Consumer Staples, and Financials.
- According to a report from CNBC, 88% of Financials and 78% of Consumer Staples companies in the S&P500 pay out a dividend. This is in contrast to 37% in IT.
Have a great remainder of your weekend. We’ll speak to you next week!