There's no shortage of expensive dividend stocks available, with markets at or near all-time highs and valuations stretched. Finding truly cheap dividend stocks requires taking some risk. Qualcomm (QCOM -0.85%), Target (TGT -0.67%), and International Business Machines (IBM -0.56%) all have high yields and trade at big discounts to the market, but all three are facing challenges. Here's what you need to know about these three incredibly cheap dividend stocks.
The king of mobile chips
Shares of Qualcomm, which earns most of its profit licensing key mobile technology, sit well below their multiyear peak reached in mid-2013. A slowing market for smartphones is partially to blame, but recent lawsuits have also created a cloud of uncertainty over the company's lucrative licensing business. Both the Federal Trade Commission and Apple are suing Qualcomm, and the latter is actively withholding payments.
Image source: Qualcomm.
As a dividend stock, Qualcomm looks attractive. The stock yields roughly 3.9% based on the latest dividend payment, and the valuation is low relative to the market. After backing out the $16.9 billion of net cash and investments on the balance sheet, Qualcomm stock trades for about 12 times 2016 earnings. The lack of royalty payments from Apple and its contract manufacturers could depress earnings going forward, and it's unclear when these issues will be resolved.
Any threat to Qualcomm's licensing business, which generated $1.96 billion in pre-tax income during the second quarter compared to just $475 million from the chip business, is a major problem. If these lawsuits lead to lower licensing payments in the future, Qualcomm stock will be in trouble. It's hard to put odds on different outcomes, though.
For dividend investors, a cash-rich balance sheet, a cheap valuation, and a high dividend yield make Qualcomm stock attractive. There's a risk that the lawsuits go terribly wrong, but the dividend should be safe under most scenarios.
A retailer looking to adapt
With online retail only growing in popularity, Target is being forced to reinvent itself. The stock has been hammered over the past six months, down 30% since early December. A rough holiday quarter, which featured slumping comparable sales and lower-than-expected margins, contributed to the decline. Target sees lower gross margins going forward as it aims to keep its prices competitive.
Target won't be trying to become Amazon. Instead, the company plans to invest in what it calls "a smart network of physical and digital assets." The company is opening small urban stores in various locations, including Manhattan and Denver, as part of that plan. Target is also doubling down on exclusive brands, with plans to launch more than 12 new brands over the next two years, in categories representing $10 billion of annual sales.
A small-format Manhattan store. Image source: Target.
Target is a dividend aristocrat, having increased its dividend annually for 45 years in a row. With the stock price beaten down, the dividend currently yields about 4.4%. The stock trades for just 11.7 times 2016 earnings, although earnings are expected to take a hit due to Target's various initiatives. Based on the average analyst estimate for 2017 earnings, Target's forward P/E ratio is 13.
It's hard to predict which retailers will successfully evolve and thrive in this new age of retail. But dividend investors could do a lot worse than betting on a company with a decades-long track record of dividend increases.
Pessimism is back for IBM
A recent string of bad news has pushed down shares of IBM, erasing some of the gains the stock enjoyed last year. First, Warren Buffett disclosed that he had reduced his massive stake in the company. Buffett's Berkshire Hathaway still has a multibillion-dollar stake, but the Oracle of Omaha has lost quite a bit of confidence in the company.
Image source: IBM.
Second, IBM came up short of expectations when it reported its first-quarter results, primarily due to a delay in the closing of a few major deals. The good news is that IBM still expects to grow per-share adjusted earnings this year. But the timing of the company's return to revenue growth remains uncertain.
For dividend investors, IBM offers a high yield and a cheap valuation. After a recent dividend increase, IBM's dividend now yields just shy of 4%. And with expected adjusted earnings of at least $13.80 per share this year, the stock trades for just 11 times forward earnings.
My guess is that revenue will need to start growing again for the stock to recover, and that will require IBM's growth businesses to outpace declines in its legacy businesses. That hasn't happened yet, and it's unclear when it will. For dividend investors with some patience, though, IBM looks like a solid choice.
