With interest rates set to rise this year, many dividend investors are likely worried that their stocks will slip as bond yields become more attractive. While some dividend stocks will inevitably decline, investors can still find some low-risk income plays that have high yields and cheap valuations. Let's take a look at three such stocks -- AT&T (NYSE:T), Cisco Systems (NASDAQ:CSCO), and Reynolds American (NYSE:RAI).
The Dividend Aristocrat: AT&T
AT&T's forward yield of 4.8% is much higher than the S&P 500's 2.1% yield, and it's comfortably supported by a payout ratio of 81%. It spent 72% of its free cash flow over the past 12 months on dividends. AT&T has hiked its dividend annually for over three decades, surpassing the 25-year threshold for becoming a Dividend Aristocrat.
In addition to being a rock-solid income play, AT&T is becoming a growth play again with its acquisition of DirecTV and proposed takeover of Time Warner. Bundling its pay TV, wireless, and broadband internet services together gives the telco giant tremendous leverage in delivering media content across multiple platforms -- especially if it excludes that content from data charges across its own networks.
Analysts expect AT&T's revenue and earnings to rise 12% and 5%, respectively, this year. The stock already rallied 22% over the past 12 months, but it remains surprisingly cheap at 17 times earnings -- which is much lower than its industry average of 25.
The mature tech stock: Cisco Systems
Cisco Systems is often described as a slow-growth, "mature" tech stock. Analysts expect the networking giant's revenue to fall 2% and its earnings to rise less than 1% this year due to tough competition in routers and switches, slower enterprise spending, and the disruptive threat of cloud-based networking solutions that require less hardware.
Due to those challenges, Cisco trades at just 15 times earnings, which is much lower than its industry average of 25. Its forward yield of 3.5% is also much higher than the market average, and it's easily supported by a payout ratio of 47%. It spent 40% of its FCF on those dividends over the past 12 months. Cisco has hiked its dividend every year since it started paying one in 2011.
Cisco rallied more than 20% over the past 12 months, but those gains can mainly be attributed to the popularity of dividend stocks in a low-interest-rate environment instead of any real enthusiasm for its core business. But looking ahead, Cisco might rekindle its top-line growth with the robust growth of its cybersecurity business, the growth of its newly acquired Jasper Internet of Things (IoT) platform, and additional acquisitions.
The overlooked tobacco play: Reynolds American
Tobacco stocks are often considered solid income investments, but some investors only focus on the two former halves of the Philip Morris empire -- Altria and Philip Morris International. Altria is a good domestic play, but its price-to-earnings ratio (P/E) of 25 is higher than the industry average of 22. Meanwhile, PMI's all-overseas business is too exposed to the strong dollar.
A better play is Reynolds American, which became the second-largest domestic cigarette maker after it acquired Lorillard last year. Reynolds trades at just 15 times earnings and generates most of its revenue in the United States. Reynolds' flagship Camel brand counters Altria's Marlboro. The company also dominates the menthol market with Newport, leads the e-cigarette market with Vuse, and controls the "additive-free" niche with Natural American Spirit.
Reynolds pays a forward yield of 3.3%, which is supported by a payout ratio of 44%. Its dividend payments have eclipsed its free cash flow (FCF) over the past year due to the Lorillard acquisition, but that payout ratio should drop to manageable levels as its FCF grows again. Reynolds has raised its dividend annually for seven straight years.
Analysts expect Reynolds to post 4% sales growth and 11% earnings growth next year -- which tops Altria's projected sales growth of 2% and earnings growth of 10%. Reynolds could eventually be hurt by declining smoking rates, but it can likely raise prices, cut costs, and repurchase stock to boost its earnings for years to come.
The bottom line
There's no perfect dividend stock that can be bought and forgotten about, but AT&T, Cisco, and Reynolds American won't cause you to lose much sleep. All three stocks trade at discounts to their industry peers, have hiked their dividends for years, and have manageable payout ratios. I personally own shares of all three stocks and haven't ever felt compelled to babysit them.