The S&P 500 currently trades at 25 times earnings, its highest multiple in seven years. Meanwhile, low interest rates are causing income investors to buy more dividend yielding stocks instead of bonds -- which has inflated the multiples on many dividend stalwarts to historically high levels. Johnson & Johnson and General Mills, for example, respectively trade at 23 and 24 times earnings, but their yields are near multi-year lows.
It might seem hard to find any cheap dividend stocks in this frothy market. However, income investors should note that "mature tech" stocks like Apple (NASDAQ:AAPL), Cisco (NASDAQ:CSCO), and IBM (NYSE:IBM) still offer decent dividends with multiples under 15.
Apple currently trades at just 12 times earnings, which is much lower than the industry average of 17 for electronic equipment companies. It's raised its dividend every year since 2012, and spent just 24% of its free cash flow on those payments over the past 12 months. That low payout ratio indicates that it has plenty of room to raise its dividend.
Apple currently pays a forward yield of 2.1%, which might not seem impressive compared to the S&P 500's average yield of 2%. However, Apple's much lower P/E gives it more downside protection than the overall market.
Looking ahead, the greatest challenge for Apple will be to decrease its dependence on the iPhone, which generated over half its sales last quarter and is struggling to grow annually in a saturated smartphone market. Apple plans to do that by growing its services (Apple Pay, Apple Music, Apple Care, iTunes), selling more iOS devices to enterprise customers, and potentially developing new products like VR headsets, wearables, and electric cars. However, those plans won't boost its growth in the near term -- analysts still expect its revenue and earnings to respectively fall 8% and 10% this year.
Cisco has a P/E of 15, which is lower than the industry average of 25 for networking and communication device companies. The company has hiked its dividend annually over the past five years, and spent just 38% of its free cash flow on those payments over the past 12 months. It currently pays a forward yield of 3.3%, which is nearly double the 1.7% yield of its rival Juniper Networks.
But like Apple, analysts don't expect Cisco to post much growth in the near term. Sales and earnings are expected to improve just 1% and 3% respectively this year. Demand for Cisco's routers and switches, which generated nearly half its sales last quarter, remains tepid -- router revenues fell 6% annually as switch revenues inched up 2%. To make matters worse, cloud-based networking platforms from rivals like Arista Networks are reducing demand for traditional networking equipment.
However, Cisco plans to diversify away from routers and switches with its higher-growth security, service provider video, and collaboration services. Cisco also plans to continue expanding inorganically across the Internet of Things, which it expects to link up to 50 billion devices to by 2020. Big enterprise partnerships with Apple and IBM will also widen its moat against smaller rivals with bundles of hardware and software services. These moves can help Cisco continue to grow in a cloud-first, mobile-first world.
IBM trades at 13 times earnings, compared to the average P/E of 21 for the IT services industry. It's raised its dividend annually for 16 years, and spent 36% of its free cash flow on those payments over the past 12 months. It currently pays a forward yield of 3.5%.
Like Cisco, IBM is pivoting away from older businesses toward newer ones. Its core IT services, hardware, and software businesses have struggled over the past few years due to slower enterprise spending, tough currency headwinds, and fierce competition from cloud giants like Amazon and nimbler IT rivals like Accenture. As a result, Big Blue's sales have fallen annually for 17 consecutive quarters.
IBM has been trying to break out of that rut by divesting lower-margin businesses, acquiring cloud-based companies, and investing more heavily in its machine learning platform Watson. It's dubbed its five higher growth businesses of cloud, mobile, analytics, security, and social as its "strategic imperatives." Revenue from those businesses rose 12% annually last quarter and accounted for 38% of its sales over the past 12 months. That growth is decent, but it's unclear how long it will take those businesses to boost IBM's top line growth back into positive territory.
The key takeaway
Apple, Cisco, and IBM's valuations remain at fairly cheap levels because investors aren't impressed by their growth prospects. However, that leaves their multiples at fairly low levels, and their dividends are all easily supported by their free cash flows. This makes them pretty reliable income generators in a market filled with overvalued dividend stocks.
Leo Sun owns shares of Amazon.com, Cisco Systems, and Johnson and Johnson. The Motley Fool owns shares of and recommends Amazon.com, Apple, Arista Networks, and Johnson and Johnson. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Accenture and Cisco Systems. 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.
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