The COVID-19 pandemic unleashed both a historic public health crisis and the potential of tech stocks with the embrace of digital communications and business transactions. The stay-at-home culture has encouraged the use of this technology like never before.

Growth stocks in the technology space have surged to new highs. But now their growth is slowing — the pandemic year is coming to an end and the first COVID-19 vaccines are being rolled out. However, given the uncertainties surrounding the pace of economic recovery, securing a steady stream of income is still important and not necessarily easy.

It may be time to roll with the market’s momentum and enhance one’s portfolio with stocks that pay dividends and deliver earnings growth potential. The technology sector may currently be the best for finding stocks that possess this combination.

How to identify good dividend stocks 

When we speak of dividend stocks, the first thing that comes to mind is market leaders that enjoy stable cash flows and growing earnings. Dividends are a company’s way of sharing profits with its shareholders. A company pays dividends from its earnings. Dividends are generally recurring payments to shareholders and are usually paid by companies that have free cash flow.

In a dividend stock one should look at three aspects primarily:

• Earnings
• Dividend payout ratio
• Dividend history

First, a company whose earnings per share (EPS) is stable and growing is better equipped to pay regular dividends. Second, if a company pays out 100% of its earnings in dividends, it means it is not investing in the businesses. A company cannot sustain a 100% dividend payout for long. Hence, look for companies that have a balanced distribution of their cash flows.

Last, look at a company’s dividend history. If it has stood firm in a crisis and continued to pay dividends for a decade or so without any major cuts, it is a good dividend stock. One might also want to see how frequently and how much the company has increased its dividends in the last few years and its potential to increase future dividends.

The dividend opportunity 

While dividend stocks are considered a lower risk than growth stocks, they still have some risks. One of the biggest risks in dividend stocks is any disruption in the company’s earnings potential. During the pandemic, many cyclical tech companies’ revenues took a hit, raising concern around their earnings.

When profits take a hit, a company’s management often suspends share buybacks and cuts dividends. In that scenario, the company’s stock price falls as investors drop it in fear of dividend cuts. This creates an opportunity to buy strong dividend stocks at a discounted price. These stocks are seeing a recovery in earnings.

Here are three tech companies —Broadcom Inc. (AVGO), Seagate Technology PLC (Ireland) (STX), and NetApp, Inc. (NTAP) — that bear the traits of good dividend stocks. They currently have a dividend yield of 3.2%, 4.14%, and 3.1%, respectively.

Broadcom Inc. (AVGO)

AVGO is a leader in the communication semiconductor space and is now expanding into the enterprise software and storage space. The company’s CEO, Hock Tan, is known for his successful mergers and acquisitions (M&As). AVGO acquires large companies that are market leaders in their segments and enjoy strong cash flows. It integrates these companies and derives cost savings, thereby increasing its earnings and cash flows.

AVGO has a 10-year history of paying incremental dividends. In December, it increased its dividend per share by 10.8% to $3.6 in the first quarter of fiscal 2021, which equates to $14.4 annually.

AVGO has a lot of room to grow its EPS as it taps the 5G opportunity. Analysts expect AVGO’s EPS growth to accelerate to 15% in fiscal 2021 from 4.08% in fiscal 2020 as the 5G rollout kicks in. Its strong EPS growth could see a significant increase in dividends in December 2021 and beyond.

How does AVGO stack up for the POWR Ratings?

A for Trade Grade

A for Buy & Hold Grade

A for Industry Rank

B for Peer Grade

A for overall POWR Rating

The stock is also ranked #3 stock in the 86-stock Semiconductor & Wireless Chip industry.

Seagate Technology PLC (Ireland) (STX)

STX is a leader in the enterprise hard-disk drive (HDD) market, which is cyclical in nature. The company has been paying regular dividends since 2003. However, it has not t increased its dividend at regular intervals given the cyclical nature of its business. After four years of paying stable dividends, it increased its dividend per share by 3.2% in December 2019 and another 3% this month.

STX experienced declining revenue last year due to demand weakness in the data center market. Its non-GAAP EPS declined 4.3% year-over-year to $4.95 in fiscal 2021. But the EPS was sufficient to pay its annual dividend per share of $2.6.

STX is witnessing the return of demand in the data center market, but it will take time to reflect in the company’s EPS. Analysts expect its EPS to fall 4.6% to $4.72 in fiscal 2021 and then surge 14% to $5.39 in fiscal 2022. Looking at the estimates and payout, STX’s dividends seem safe. There is a possibility the company might increase its dividends next year as well on the back of strong EPS growth.

STX is rated a “Strong Buy” in the POWR Ratings. It holds straight “A” in Trade Grade, Peer Grade, and Buy & Hold Grade and a “B” for Industry Rank. It is also the #1 ranked stock in the 8-stock Technology – Storage industry.

NetApp, Inc. (NTAP)

NTAP is a strong competitor of STX in the enterprise storage market with its all-flash arrays. However, it is shifting to cloud storage solutions. CEO George Kurian describes the new NTAP as “a cloud-led, data-centric software company.”

NTAP has a seven-year history of paying regular dividends and increasing them at regular intervals. However, it did not increase its dividend this year because it is transitioning to a cloud company due to demand weakness in the data center market. Its non-GAAP EPS declined by 10.4% year-over-year to $4.05 in fiscal 2020. But the EPS was sufficient to pay its annual dividend per share of $1.92.

Just like STX, NTAP is seeing the return of data-center demand. Analysts expect its EPS to fall 4% to $3.89 in fiscal 2021 and then surge 12.1% to $4.36 in fiscal 2022. NTAP could probably announce its next dividend increase in 2022 as EPS grows.

NTAP is rated “Strong Buy” in our POWR Rating system. It also has an “A” for Trade Grade and Buy & Hold Grade, and a “B” for Industry Rank. In the Technology – Storage industry, it is ranked #2.

Investor takeaway 

STX and NTAP stocks were hit significantly by the coronavirus pandemic. These stocks steadied themselves in November and have recovered their normal growth trend. We think the three stocks will benefit from the return of demand in the data center market, which would likely result in higher dividends in the coming years.

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AVGO shares were trading at $412.53 per share on Monday afternoon, up $6.71 (+1.65%). Year-to-date, AVGO has gained 35.35%, versus a 15.16% rise in the benchmark S&P 500 index during the same period.

About the Author: Puja Tayal

Puja is a seasoned writer working with financial publishing companies like Motley Fool Canada and Market Realist. With over 13 years of experience in the field of fundamental research, she brings a blend of comprehensive, well-researched insights into her articles. More...

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