Buying stocks that pay market-beating dividend yields can give your annual performance some extra pop, but not every company with a high dividend yield deserves to be in your income portfolio. The dividend yield of some companies are high because their businesses are struggling. Rather than risking owning a high-yield/high-risk stock, income investors might be better off buying industry titans with solid balance sheets that are trading at reasonable valuations. For example, these three companies could be the perfect addition to income portfolios right now.
Big Blue's big transformation
A forward P/E ratio of 11.3 and a 3.5% dividend yield makes International Business Machines Corporation (NYSE:IBM) too alluring for dividend investors to ignore, especially since it's knee-deep in transforming itself from a stodgy PC and networking company into a cloud, analytics, engagement, and security giant.
IBM's shares have rallied 18% this year because sales associated with its "strategic imperatives" are running at an annualized $30.7 billion pace. IBM's cloud business revenue is clocking in at an annualized $11.6 billion exiting Q2, and given that the global public cloud services market could reach $204 billion this year, up 16.5% year over year, there's plenty of market share left to conquer.
If IBM continues to capture share in this massive market, then it should be able to keep building on what is truly an impressive dividend track record. The company has paid investors a dividend for 100 years and it has increased its dividend payout in each of the past 21 years, including a 7.7% hike in April.
Admittedly, IBM's transformation isn't complete and slowing sales in its legacy businesses is creating profit headwinds. After reporting earnings per share of $14.92 last year, industry watchers think IBM's EPS will fall to $13.51 this year. Nevertheless, IBM is still a handsomely profitable company that's kicking off plenty of cash flow, so picking up shares now while they're trading at a low double-digit multiple to next year's earnings makes a lot of sense to me.
Microsoft's plans are paying off
IBM's not the only technology giant undergoing big changes that dividend investors ought to consider buying. Microsoft Corp. (NASDAQ:MSFT) is also transitioning itself into a cloud giant and its 2.5% dividend yield and forward P/E of less than 18 makes it a compelling buy, too.
In its recently reported fiscal fourth quarter, Microsoft's productivity and business processes segment sales increased 8% in constant currency to $7 billion and intelligent cloud segment sales increased 10% in constant currency to $6.7 billion. That growth more than offset headwinds from a slowing PC business, resulting in overall year-over-year companywide constant currency revenue growth of 5%.
Microsoft thinks it can generate $20 billion in commercial cloud revenue in 2018, and if so, that would mean some pretty nice upside from here for that business. Commercial cloud sales were running at an annualized $12.1 billion clip last quarter.
Fueling that growth will be Office 365, the company's online productivity software suite, and Azure, its app building and management solution. Last quarter, commercial Office 365 sales grew 54% and Azure sales more than doubled from a year ago.
The company should also enjoy sales and profit tailwinds due to growth for its Surface laptops, Xbox Live, and Internet search businesses. Surface sales increased 9%, Xbox Live membership grew 33%, and search revenue rose 16% year over year last quarter.
Overall, Microsoft is generating $5.5 billion in quarterly free cash flow, and since Microsoft boasts $100 billion in cash on its balance sheet, there's little reason for me to doubt that it will remain one of the most dividend-friendly companies in technology.
Pfizer's back to growth
After suffering through years of slowing sales due to patent expiration on its multibillion-dollar cholesterol drug Lipitor, Pfizer, Inc.'s (NYSE:PFE) top and bottom lines are poised to head higher again. If so, then buying shares at 13 times next year's earnings estimate and pocketing a healthy 3.4% could be savvy.
Pfizer's research and development has led to the launch of fast-growing cancer drugs and its deep pockets are fueling acquisitions that are further entrenching it as a global biopharma powerhouse. The company's cancer drug sales jumped 54% to $1.1 billion last quarter, and in the past year, Pfizer has acquired Hospira, a leader in specialty biologics; Anacor, a developer of a new topical eczema therapy; and Medivation, the maker of the multibillion-dollar prostate cancer drug Xtandi.
Pfizer's growing oncology franchise has already led to six consecutive quarters of operational growth and the combination of organic growth and mergers and acquisitions has management guiding for sales of $51 billion this year, up from $49 billion last year (and that doesn't include Medivation's contribution because that deal hasn't closed yet). Importantly, Pfizer's thinks EPS will reach $2.38 this year, up from $2.20 last year, and if management delivers on that outlook, then I think more dividend increases are on the horizon. Pfizer has increased its dividend payout by 50% since 2012 and that was when sales were sliding.
Overall, ongoing R&D wins and additional M&A should continue to fuel dividend-friendly cash flow and that makes this stock one of my favorites dividend stocks to buy in healthcare.
Todd Campbell owns shares of Medivation and Microsoft. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. Like this article? Follow him on Twitter where he goes by the handle @ebcapital to see more articles like this. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.