Many investors believe that an interest rate hike in September could cause some higher-yielding dividend stocks to give up some of their big gains over the past year. If interest rates rise, bonds become safer income investments for capital preservation than dividend stocks.
Moreover, the quest for yield in a low interest rate market has reduced the yields of many stocks to all-time lows while boosting their valuations to all-time highs. Those stocks will likely fall first as interest rates rise.
But in the tech sector, there are still some solid income stocks with low valuations and yields topping 3%. Let's take a closer look at three such companies -- IBM (NYSE:IBM), Qualcomm (NASDAQ:QCOM), and Garmin (NASDAQ:GRMN).
IBM has raised its dividend annually for the past 16 years, and currently pays a forward yield of 3.5%. Big Blue spent just 36% of its free cash flow on dividends over the past 12 months, which leaves it plenty of room for dividend hikes in the future.
IBM's main problem is its lack of revenue growth. Sluggish enterprise spending, currency impacts, and tough competition have caused its sales to fall annually for 17 consecutive quarters. The company is trying to reduce the weight of its older IT, hardware, and software businesses by divesting weaker units and investing heavily in the higher growth "strategic imperatives" of mobile, cloud, social, security, and analytics. But the turnaround has been tough, and analysts expect its revenue and earnings to fall 3% and 10% respectively this year.
IBM's upside will be limited by those headwinds, but its downside should also be limited by its yield and P/E of 13, which is much lower than the IT services industry average P/E of 21. This means that IBM could be better insulated from interest rate hikes than other dividend stocks trading at higher valuations.
Qualcomm, the biggest mobile chipmaker in the world, has raised its dividend for 13 straight years. It spent 46% of its FCF on dividends over the past 12 months, and currently pays a forward yield of 3.4%.
Like IBM, Qualcomm has struggled to grow it sales and earnings. Its chipmaking business, which generates most of its revenues, is losing market share to cheaper rivals like MediaTek and first-party chips from major OEMs like Apple and Huawei. Its patent licensing business, which generates most of its profits, faces defiant OEMs and regulators which claim that its fees (up to 5% of the wholesale price of each phone) are too high. As a result, analysts expect Qualcomm's sales and earnings to both fall 8% this year.
But on the bright side, robust sales of Qualcomm's well-received Snapdragon 820/821 chips and new chips for wearables, connected cars, drones, and other Internet of Things gadgets could enable it to post 2% sales growth next year. New licensing deals with Chinese OEMs and agreements with regulators should also reduce the pressure on its licensing business, potentially boosting earnings by 11% next year.
Despite those catalysts, Qualcomm still trades at just 18 times earnings, which is lower than the industry average of 25 for the communication equipment industry.
I previously highlighted GPS and wearables maker Garmin as a safer play on the fitness tracker market than market leader Fitbit (NYSE:FIT). Whereas Fitbit doesn't pay a dividend, Garmin has hiked its dividend annually for four consecutive years, and pays a forward yield of 4.1%. The company has spent 77% of its FCF on dividends over the past 12 months.
Garmin isn't a high growth company. Analysts expect the company to post just 3% sales growth and 2% earnings growth this year. Sales rose 5% annually last quarter, with fitness device revenue rising 34%, outdoor device revenue surging 23%, marine GPS revenue rising 8%, and aviation GPS revenue improving 6%. The only weak spot was its auto GPS revenue, which fell 18% due to smartphones replacing stand-alone GPS units in cars.
Garmin uses a scattergun strategy in wearables, with specialized trackers for golf players, swimmers, and other athletes. This helps it reach more niche markets than Fitbit, which mainly splits its devices between active fitness trackers and more fashionable smartwatch-like devices.
Whereas Fitbit's gross margin has been declining due to higher R&D and marketing expenses, Garmin's has been rising thanks to a greater mix of higher-margin products across its portfolio. Garmin trades at 19 times earnings, which is lower than both Fitbit's P/E of 32 and the industry average of 31 for makers of scientific and technical instruments.
Should you buy these stocks today?
I believe that IBM, Qualcomm, and Garmin offer lower valuations and safer yields than many other stocks on the market, but they're certainly not immune to any big interest rate hikes. Therefore, investors should look beyond these companies' dividends to see if their core businesses are worth investing in.