King of dividends? Banking sector no longer tops

Investors in the U.S. who used to rely on financial stocks for dividends can turn to an unlikely successor: information technology.

Companies in the IT industry eclipsed financials in total dividend payouts for the first time in the third quarter. That marks a change as IT companies generally have held onto cash so they could reinvest it in research and development or make acquisitions. Now, facing pressure from yield-starved shareholders, firms such as Cisco Systems Inc. and Microsoft Corp. are choosing to disburse some of that cash by introducing or increasing dividends.

“Tech has excess cash and the ability to pay, whereas financials will take a long time to get back to where they were,” said Howard Silverblatt, a senior index analyst at Standard & Poor’s in New York.

IT stocks accounted for 9.2 percent of the almost $210 billion in dividends paid out as of Oct. 7 compared with 8.9 percent for financial stocks, according to data compiled by S&P. In 2007 before the recession, financial stocks made up 30 percent of dividends and IT was 5.7 percent.

Companies in the IT sector are also maturing, which means cash flow has risen and capital needs have fallen, said James Meyer, chief investment officer of investment management firm Tower Bridge Advisors in West Conshohocken, Pennsylvania, whose typical clients have $1 million or more in investable assets.

As of Oct. 6, 73 stocks in the S&P 500 Index paid dividends exceeding the average corporate bond yield of 3.6 percent, more than at any time in at least 15 years, data compiled by Bloomberg and Bank of America Corp. show. The average yield for a stock in the IT industry that pays dividends is 1.9 percent compared with 1.4 percent for a financial stock, based on data from S&P.

Reduced Payouts

Many financial companies reduced or eliminated their payouts because they accepted funds from the Troubled Asset Relief Program and are concerned about meeting certain capital requirements before paying them again, said Jeff Rubin, director of research at Westport, Connecticut-based Birinyi Associates, a money management and research firm.

Low fixed-income rates are also fueling the hunt for higher yields. The two-year Treasury note yield fell to a record low of 0.3512 percent yesterday. The 10-year security’s yield dropped to 2.3552 percent on Oct. 6, the lowest level since January 2009.

Clients are seeking dividend-paying stocks of high quality because they want income and companies “that they can go to sleep with at night,” said Hank Smith, chief investment officer of Radnor, Pennsylvania-based Haverford Trust Co., which manages about $6 billion. Haverford’s Quality Growth Portfolio, which has about $3 billion invested in dividend-paying companies, allocates 21 percent to technology stocks and 13 percent to financials.

Telecommunications Yields

Although more IT stocks are paying dividends, investors should remember they still pay less than other industries, Rubin of Birinyi Associates said. Telecommunications and utilities offer the highest yields of 6.1 percent and 4.5 percent, respectively. And banks may start paying higher dividends again as soon as 2011, he said.

Helen Modly, a fee-only financial planner at Focus Wealth Management in Middleburg, Virginia, said she’s adding dividend exchange-traded funds to portfolios for the first time because of clients’ requests for yield. She said she prefers SPDR S&P Dividend ETF, which has returned 13 percent this year, and Vanguard Dividend Appreciation ETF, which has returned 7.2 percent, because they’re less risky than owning individual stocks.

The SPDR S&P fund, which yields 3.3 percent, has attracted $1.36 billion in net new inflows during the first eight months of the year, said Jim Ross, global head of ETFs at State Street Global Advisors in Boston. The greatest allocation in the fund is to utilities, at 21 percent.

Tax Implications

In one of Vanguard Group Inc.’s actively managed dividend funds, the Equity Income Fund, IT has increased to 8 percent from 2 percent of assets, said Linda Wolohan, a spokeswoman for the Valley Forge, Pennsylvania-based mutual fund company.

Last week Fidelity Investments changed the benchmark for its Strategic Dividend and Income Fund to the MSCI USA High Dividend Yield Index from the Russell 3000 Value Index to increase yield, said Chris Sharpe, co-portfolio manager of the fund, who’s based in Boston.

The move resulted in holdings in the financial industry dropping and IT increasing. As of June 30, the MSCI Index had 3.5 percent in financials compared with 30 percent in the Russell Index and IT had 5.8 percent compared with 5 percent in the Russell Index, according to Fidelity.

For investors who opt to put money in dividend-paying stocks, there are tax implications to consider. Many dividends have been taxed at a federal rate of 15 percent since 2003. Next year, if Congress doesn’t act, they may be taxed as ordinary income, as high as 39.6 percent.