When we talk about tech stock investing, we hear discussions of all sorts about different measures used for picking stocks. For example, some tech investors use year-over-year revenue growth. Others subscribe to a theory that has been floating around for many years, that the secret to picking tech stocks was…
looking at the percentage of cash flows spent on research and development.
All too often, tech stock analysis consists of storytelling and searching for ideas that will change the world, something I’ve heard thousands of times during my career. The number of companies that actually did change the world probably totals up to a few dozen over three decades.
Some of those beat the market. Others did not.
I have found a variable that can help tech investors spot promising opportunities to identify technology companies that have higher probabilities of providing market-beating returns: dividends.
Note a stock’s dividend yield: investors who want higher dividends with an overall total return would be smart to look into high-yield tech stocks as part of their income strategy. The key to using dividends to find market-beating tech stocks is to look at the rate of their dividend growth. It doesn’t matter how high the dividend is at any given time. We want to see companies that are consistently growing their dividends.
A tech company that pays a dividend is making a statement. It tells the world: “We are generating enough cash to pay the bills, hire great people, and fund our future growth plans as well as R&D. In fact, we are generating so much cash we have some left over to pay out to our investors.”
Ideally, we want to limit our universe of companies to those who are increasing their payout by at least 20% annually. Growing a dividend at that high a rate says that things are just continuing to get better.
Once we have a universe of tech companies that are growing their payouts at high levels, we want to make sure we only own those that really do have a wonderful business that just keeps getting better. We want to use a financial checklist to make sure our companies are in excellent financial shape and have what it takes to keep growing the business.
I prefer the nine-point checklist developed by Professor Joseph Piotroski when he was at the University of Chicago – known as the “Piotroski F-Score”. This is a list of nine criteria of profitability, leverage, and efficiency. On each criterion, a firm can either get one or zero points – pass or fail.
I limit my universe of tech stocks with paid dividend growth to just two to three with the highest scores on the Piotroski checklist.
Using this simple method for picking tech stock winners has crushed the S&P 500 over the past decade and even edged at the tech-heavy NASDAQ 100…
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