With interest rates at historically low levels, it's quite a challenging environment for income investors to earn a decent income. The dividend yield on the index is just 1.37%, the lowest in 150 years, excluding the peak of the dotcom bubble two decades ago. That situation is not helpful if you are investing to manage your monthly cash flows.
Today we analyze two heavyweights – AT&T (NYSE:) and International Business Machines (NYSE:) – to understand which high-yield stocks might be a better buy.
1. AT&T
America's largest telecom operator, AT&T, offers an attractive risk-return proposition for income investors. With an annual return of 7.11%, investors can achieve one of the best returns available from a blue-chip stock with a long track record of paying dividends.
But that return is not without risk. Shares of the Dallas-based company have underperformed the benchmark S&P 500 for years. They have fallen 27% in the past five years – a period in which the S&P 500 more than doubled. Shares traded at $28.98 at yesterday's close.
T Weekly Chart
AT&T's dismal performance over the past five years also reflects the company's debt-laden acquisition strategy, which has so far failed to unlock value for its shareholders. The company created doubts about its future payouts last month when it announced it will cut its dividend as part of a deal to combine its media assets with those of Discovery (NASDAQ:).
While AT&T has not officially cut its quarterly dividend of $0.52-per-share, the company said the payout would be 40% to 43% of free cash flow, which is expected to be about $20 billion by 2022. , when the deal is expected to close. That would be about $8.3 billion in the middle, compared to $15 billion paid out to shareholders in 2020
With dividend cuts, could AT&T stock offer better value as it becomes a leaner company after divesting its WarnerMedia assets?
Some analysts think this will be the case.
UBS analyst John Hodulik, who upped his rating to buy from neutral, said in a recent note that AT&T's leaner version had a clearer path to improving cash flow:
“We see a favorable return on risk at the current valuation, given a more simplified set of connectivity-based assets, lower dividend payout (~40% vs. ~60% post-DTV deal), better understanding of [earnings before interest, taxes, depreciation and amortization] ] , growth and lower leverage.”
The dip in dividends, which has led some investors to move towards the stock, doesn't seem quite as drastic when looking at the overall results of the Discovery deal, UBS said.
Added the note:
"While AT&T cut its dividend by ~45%, the deal structure is estimated to yield ~$7-8 per share in one-time, tax-free payment (in the form of DiscoveryWarner shares), equivalent to 4-5 years of lump-sum dividend .”
2. IBM
Many investors do not have a favorable view of International Business Machines because of the poor growth performance over the past decade.
The 109-year-old tech giant has been slow to restructure its business, at a time when demand for its big-frame servers and other hardware fell and its customers began storing data on cloud services from rivals such as Amazon (NASDAQ 🙂 and Microsoft (NASDAQ:).
But there are some clear signs that the company is succeeding in its turnaround, making its 4.5% dividend yield attractive to long-term investors. New York-based IBM posted its first revenue increase in 11 quarters in April, driven by demand for cloud services. IBM's revenue from Red Hat, which it bought for $34 billion in 2019, also grew 17% in the first quarter.
These numbers helped push IBM stocks up 18% this year and outperformed many megatech stocks.
IBM Weekly Chart.
Arvind Krishna, who took over as CEO from Ginni Rometty last April, focuses on artificial intelligence and the cloud to revive growth. Krishna has reorganized the company's operations around a hybrid cloud strategy, which allows customers to store data on private servers and across multiple public clouds.
IBM is a better dividend stock than AT&T in our opinion, especially after the clear shift of new management to cloud computing, an area that is growing rapidly. These moves are encouraging and could unlock the value of IBM stock, which has increased dividends for 25 years in a row.
By the end of Tuesday, IBM will trade at $149.07 and pay a quarterly dividend of $1.63 per share.
Starting point
Investing in turnaround situations can yield huge returns over time. But these companies certainly carry more risk, so investors should be very careful when deciding which high-yield stocks to select.
