If it seems like the rally in the technology sector has run its course, you're not alone. Social media companies have far and wide exploded higher, while cloud-computing stocks with no discernible profit potential in the near term have been off to the races for more than a year.
But there are still patches of the tech sector where strong growth is not only possible, but probable. Spending from telecom services companies has been fierce and competitive in an effort to expand their IT infrastructure and cloud bandwidth to stand out from the crowd. The end result is that these billions of dollars being spent on next-generation infrastructure upgrades are going to trickle-down to the telecom equipment sector and could sustain growth here for years to come, whether or not the global economy cooperates.
With that in mind today I'm suggesting we take a closer look at two communication equipment dividend-paying stocks that appear to be buy-worthy, while also highlighting a dividend-paying communication equipment supplier that investors might be best off avoiding.
Two communication equipment dividends you can buy
Without further ado, here are two communication equipment stocks you can consider buying right now.
Qualcomm is by far the dominant leader in CDMA wireless technologies used in smartphones, such as Apple's iPhone and the Samsung Galaxy S5. What keeps Qualcomm at the front of the pack by a mile is its collaborations with key wireless technology producers around the globe and its world-class patent portfolio.
In addition to providing technologies that enhance consumers' 3G, 4G, and 4G LTE experience, it's also an innovative leader. Last year the company introduced the world's first global LTE chip known as the RF360 Front End Solution. As telecom companies around the world have developed their 4G LTE networks each has been reliant on its own unique LTE band, thus requiring smartphone developers to introduce mobile devices that would read that specific band in each region. Qualcomm's RF360 can combine those bands upfront, virtually eliminating the need for an RF chip in newer smartphones, and reducing the need for smartphone developers to produce different model mobile devices for different regions.
Of course, Qualcomm isn't without its own set of risks. Commoditization and eventual connectivity competition could threaten Qualcomm's margins. In addition, infrastructure upgrade cycles are exactly as they sound: cyclical. This means advanced wireless countries go through peaks and troughs where Qualcomm's growth can wane. In Qualcomm's second quarter, for instance, it delivered just 4% sales growth, its weakest year-over-year growth in four years.
Yet Qualcomm's global opportunity is still enormous considering that so few emerging market countries have even saturated 3G, 4G, or 4G LTE capabilities. China Mobile (NYSE:CHL) launched its 4G or 4G LTE network this year, and this should play right into Qualcomm's hands as a major components supplier for the iPhone.
With a dividend that's grown by 500% over the trailing decade, a current yield of 2.1%, and a forward P/E of 14 with a long-term growth rate that should average between 8% and 10%, I would suggest this is a dividend stock you can consider adding to your portfolio right now.
Alliance Fiber Optic Products (NASDAQ:AFOP)
If you're willing to trade in a smaller yield in the interim for a faster revenue growth rate, yet not give up any long-term dividend growth potential, then I'd steer you toward taking a closer look at small-cap fiber-optic component producer Alliance Fiber Optic Products.
Some of you are probably not going to be comfortable with the fact that Alliance Fiber Optic is just a $300 million company and has minimal Wall Street coverage – and that's OK. When in doubt you always have a company like Qualcomm to consider. But, for those of you looking for a double-digit growth rate, then Alliance Fiber Optic is a company you'll want to monitor.
The primary growth driver at the moment for Alliance Fiber Optic is China. As the company's CEO Peter Chang noted in its first-quarter results, "While data bandwidth demands continue to increase and the next growth cycle in the fiber optics industry is emerging, we are encouraged by the prospects of business growth in the coming years, and with the progress we made serving our customers and extending our product technology in recent quarters." Chang's words appear to indicate that the infrastructure upgrade cycle in China is just starting for Alliance Fiber Optic. And, as a quick reminder, it reported record quarterly revenue of $24.9 million in Q1, up 105% from the prior-year period.
For those who think that Alliance Fiber Optic's Q1 could be a one-hit wonder, think again. With the exception of the fourth-quarter of 2013, Alliance Fiber Optic has trounced Wall Street's expectations in each of the past nine quarters. On a forward basis Alliance Fiber Optic has double-digit top-line growth potential for at least the next couple of years and is valued at less than 13 times forward earnings.
On the dividend front Alliance Fiber Optic offers a payout just once a year. It paid a dividend in 2013 of $0.15. Some might view this 0.8% yield as hardly worth their time, but you should also consider that there's more than $51 million in cash and no debt backing this payout, and that the company's share price is up about 200% since its initial payout in 2012, which has worked to push its yield lower, yet has boosted shareholder value. In other words, it's highly likely this dividend is going to head higher, and it would be wise for investors to get this company on their watchlist.
One dividend in this sector you may want to avoid
In contrast to the aforementioned two communication equipment stocks which are seeing robust growth and may continue to see improvements in their annual payouts, I would suggest putting the brakes on the following dividend-paying stock.
All told Ericsson surprised investors in a good way last week with better-than-expected profits in the second quarter led by growth in the Middle East, China, and India markets. Ericsson, despite a 1% decline in year-over-year revenue, managed to boost its gross margin by 400 basis points to 36.4% and modestly topped Wall Street's EPS estimates.
But what growth it is seeing in emerging markets regions is being trumped by weakness in its North American operations as well as the potential that a Ukraine-Russia political escalation could negatively impact its networking segment. Even its higher growth Middle East and Africa region came with a warning that political strife could slow its growth potential in coming quarters. Another way to view this data is that Ericsson's most mature markets – and where it gets the bulk of its revenue – aren't growing that quickly if at all, while it's emerging market opportunities, which account for a much smaller piece of the pie, could grow quickly, but may also run into unforeseen political issues.
The end result is that we're left with a company that has no real top-line growth and is reducing its administrative expenses and research and development costs in order to give investors the impression that margins are moving in the right direction. Cost-cutting works temporarily to inflate EPS, but it's not a long-term solution to driving organic growth.
Ericsson's payout of 3.7% might seem tempting and its forward P/E of 14 may look like a dangling carrot on a stick, but its projected three-year compounded revenue growth forecast of less than 3% leaves a lot to be desired and allows me to easily suggest that income investors look elsewhere.
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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