Many growth stocks have underperformed the market in recent months as fears of inflation have sparked a rotation toward cheaper dividend-paying stocks. However, investors shouldn't blindly buy all high-yielding stocks trading at low multiples.
IBM (NYSE:IBM), AT&T (NYSE:T), and Intel (NASDAQ:INTC) might all seem like solid blue-chip dividend stocks in this market, but their high yields actually mask some serious fundamental problems. Let's see why danger could be lurking just around the corner for these three defensive stocks.
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1. IBM
IBM became a Dividend Aristocrat of the S&P 500 last April when it raised its annual payout for the 25th straight year. It spent just 37% of its free cash flow (FCF) on its dividend over the past 12 months, it pays a forward yield of 4.5%, and its stock looks cheap at 12 times forward earnings.
Those qualities seem to make IBM a great dividend stock, but it still underperformed the S&P 500 -- in terms of price growth and total returns (which factor in reinvested dividends) -- over the past decade.
Source: YCharts
IBM couldn't impress investors because weak demand for its older enterprise software, hardware, and IT services constantly offset the growth of its newer cloud-based services.
To streamline its core business and focus on the higher-growth hybrid cloud and AI markets, IBM plans to spin off its managed IT infrastructure services into a new company called Kyndryl later this year. IBM says the two companies will initially "pay a combined quarterly dividend that is no less than IBM's pre-spin dividend per share" -- but they'll both subsequently set their own dividends.
Therefore, the "new" IBM will likely reduce its dividend to conserve cash for other investments, but competition from other cloud giants could make it incredibly difficult for the company to turn around its massive business. Kyndryl might pay a decent dividend on its own, but the market's interest in the aging IT services business could remain tepid.
2. AT&T
AT&T, which has raised its payout for 36 straight years, is another well-known Dividend Aristocrat. It pays a forward dividend yield of 7%, it spent 57% of its FCF on those payments over the past 12 months, and the stock trades at less than ten times forward earnings. But like IBM, AT&T has broadly underperformed the S&P 500 over the past ten years.
Source: YCharts
A series of massive acquisitions over the past five years -- including DirecTV, AWS-3 spectrum licenses, and Time Warner -- caused its debt levels to skyrocket, while fragmenting its business into messy silos.
AT&T initially planned to merge its wireless, broadband, pay TV, and media segments into a vertically integrated business, but recently reversed course by selling a 30% stake in DirecTV and agreeing to spin off WarnerMedia and merge it with Discovery (NASDAQ:DISCA) (NASDAQ:DISCK).
Those abrupt decisions indicate its pay TV business is still withering, and that its media division is burning too much cash while its core 5G business is starved for fresh funds to stay competitive. But just like IBM, there's no guarantee the two new companies will fare any better than the original.
AT&T also recently said it would cut its dividend to "account for the distribution of WarnerMedia" after the deal closes next year. Therefore, investors looking for stable income should cross AT&T off their lists.
3. Intel
Intel is the world's largest manufacturer of x86 CPUs for PCs and data centers, and it pays a forward yield of 2.5% while trading at just 12 times forward earnings. It's raised its payout for seven straight years, and it spent just 29% of its FCF on those payments over the past 12 months. Intel generated a better total return than IBM and AT&T over the past decade, but it still failed to beat the market.
Source: YCharts
But that's not Intel's biggest problem. Over the past several years, Intel has fallen behind TSMC, the world's most advanced chip foundry, in the "process race" to create smaller and more powerful chips.
Intel produces most of its own chips, but rival AMD outsources its production to TSMC. As a result, AMD now produces more advanced chips than Intel, while Intel has constantly tripped over its own feet with chip shortages and R&D blunders.
Many of Intel's critics believe the chipmaker should follow AMD's lead and become a fabless chipmaker. However, Intel recently doubled down by expanding its foundries, which will eventually provide services to third-party chipmakers amid the global semiconductor shortage.
That expansion already includes a $20 billion investment in two new plants in Arizona, and it plans to build more plants across the U.S. and Europe. Intel will receive some support from government subsidies, but it could sacrifice its dividend -- which consumed $5.6 billion in cash last year -- to accelerate those ambitions. Therefore, investors shouldn't consider Intel to be a stable dividend stock right now.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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