So far this year, the Dow Jones Industrial Average is underperforming the S&P 500 and the Nasdaq Composite. But that doesn't mean that all Dow stocks are doing poorly.
Caterpillar (CAT 1.59%), International Business Machines (IBM -1.05%), and Microsoft (MSFT 1.82%) are up more than 10% year to date. Here's why all three of these dividend stocks have more room to run.
Image source: Getty Images.
Caterpillar is near a cyclical high... or is it?
Lee Samaha (Caterpillar): The construction, mining, infrastructure, energy, power, and transportation machinery equipment maker has products its customers want. That much is clear from its fourth-quarter earnings report. The company's sales volume declined, taking its profit from sales volume down by $260 million year over year. However, this was more than offset by an increase in price of $982 million.
Caterpillar had a standout year, generating record sales of $67.1 billion, record adjusted operating profit of $13.7 billion, and record free cash flow (FCF) of $10 billion from its machinery, energy, and transportation segment. The latter figure was at the top of management's estimate of FCF through this economic cycle of $5 billion to $10 billion.
That said, its guidance for 2024 calls for sales similar to 2023 and FCF "in the top half" of the range given above. This guidance implies that Caterpillar's earnings may have peaked in the cycle, and Wall Street analysts expect its 2024 earnings to be similar to those of 2023.
However, it's important to remember that Wall Street history is littered with forecasters whose predictions about the earnings of cyclical companies were wrong. For example, if interest rates come down in 2024, then it's likely that Caterpillar's construction equipment sales will benefit from a pickup in construction activity. In addition, spending related to 2021's $1 trillion infrastructure bill is only starting to come through now. Moreover, lower interest rates could boost mining and energy prices, and also make investing in commodity projects more financially feasible.
If these things come together and Caterpillar's impressive pricing power still holds, then improving sales volumes and pricing could lead to Caterpillar exceeding expectations again in 2024.
IBM is a great opportunity for both AI and income investors
Scott Levine (IBM): These days, it feels as if Nvidia dominates every conversation touching on artificial intelligence (AI). But it's hardly the only AI stock in town. Tech stalwart IBM has a considerable presence in the field of AI -- one that has been growing for several years through the development of the Watson platform. In fact, Big Blue is a Dow stock that doesn't only provide AI exposure but an attractive dividend as well. Whether you're focused on investing to profit from the AI trend or looking to generate strong passive income -- or both -- IBM stock, with its forward yield of 3.4% at the current share price, is a great opportunity.
The company is starting the year with strong momentum regarding its AI business. In its fourth-quarter report, IBM noted that from the third to the fourth quarters, it nearly doubled its book of business (which the company defines as revenue, software-as-a-service contract revenue, and consulting signings) for generative AI and the Watsonx data and AI platform.
Since the start of 2024, IBM stock has raced 18.3% higher, well outperforming the S&P 500, which has climbed 7.3%. But extend your view to this time last year, and IBM stock's performance is even more impressive. While the S&P 500 has risen about 34% over the past 12 months, IBM has zoomed about 54% higher. Investors clearly were rewarding IBM for its impressive business growth. In 2024, IBM grew revenue by 3% and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) by 6%. And it generated free cash flow of $11.2 billion, its best result on that metric since 2019.
IBM Dividend Per Share (Annual) data by YCharts.
While its high dividend yield may cause some investors to be skeptical about the sustainability of the payout, IBM's history of generating strong free cash flow to support its dividend should allay concerns -- especially with management expecting free cash flow to grow by about 7% to $12 billion in 2024.
Microsoft rewards its shareholders in myriad ways
Daniel Foelber (Microsoft): Microsoft hit new all-time intraday and closing highs on March 14. And for good reason.
The company is firing on all cylinders and unlocking explosive growth through AI, namely through various Microsoft Copilots. These are tools embedded in existing applications such as Microsoft 365 and GitHub. It also offers AI assistant tools for LinkedIn and Azure AI.
Microsoft is straightforwardly leveraging AI. Ignoring the buzzword for a second, Copilots are basically just really good upgrades across its ecosystem. Like any product improvement, they should help accelerate growth. In fact, they already are.
MSFT Revenue (TTM) data by YCharts
Microsoft's 44.2% trailing 12-month operating margin is its highest in over 20 years. The company is growing relatively quickly for such a behemoth. It's hard to turn a ship that big, yet despite this challenge, Microsoft's AI monetization is having a measurable impact on its performance.
Microsoft also distributes more in dividends than any other U.S.-based company. Even with a massive stock-based compensation program, it has boosted its payouts by 63% in the last five years and reduced its outstanding share count by over 3%.
Despite being regarded as a growth company, Microsoft is increasing its dividend faster than most reliable dividend payers. Its yield may be low, but that's only because the stock price has grown much faster than the payout -- a good problem for Microsoft shareholders to have.
Microsoft should continue to outperform the Dow Jones Industrial Average and lead the market higher.
