The Internet of Things (IoT) market, which connects billions of devices to each other and the cloud, is widely expected to be the next major growth market for tech companies. Cisco believes the number of connected devices worldwide will double from 25 billion in 2015 to 50 billion in 2020.
That sounds like a great market for growth stocks. Sierra Wireless, the best-known "pure play" on the IoT market, rallied more than 65% over the past 12 months. But it's not a hot market for income investors, since many top IoT stocks -- like Sierra Wireless -- don't pay dividends.
Cypress sells programmable chips for the automotive, industrial, home automation, medical devices, and consumer electronics markets. It aggressively expanded its portfolio over the past two years, first with its merger with embedded chipmaker Spansion in 2015, then with its acquisition of Broadcom's (NASDAQ:AVGO) wireless IoT unit in 2016.
The Broadcom acquisition added Wi-Fi, Bluetooth, and Zigbee wireless technologies to Cypress' portfolio. The company also recently introduced its new PSoC microcontroller architecture for next-gen IoT devices, which it claims delivers "the industry's lowest power and most flexible solution" with integrated security features for next-gen IoT devices.
Demand for Cypress' chips surged as the number of connected devices worldwide soared -- particularly in China and Japan. That's why Cypress' revenue rose 19% in 2016, and is expected to rise another 14% to $2.2 billion this year. Its earnings surged 133% in 2016, and analysts expect 45% growth this year.
Cypress currently pays a forward dividend yield of 3.3%, but it hasn't raised that dividend since 2012. Its earnings-based payout ratio exceeds 100% due to its aforementioned mergers and acquisitions, but it spent just 82% of its free cash flow on dividends over the past 12 months -- so it probably won't cut its payout anytime soon.
Qualcomm is usually known as the biggest mobile chipmaker in the world, but it's also been launching new chipsets for wearables, drones, smart home appliances, connected cars, and other IoT gadgets. It broadened that portfolio with its purchase of IoT and automotive chipmaker CSR in 2015, and it will expand it again with its planned acquisition of NXP Semiconductors -- which will make it the biggest automotive chipmaker in the world.
Qualcomm has an edge in the IoT market because its Snapdragon chipsets have integrated modems -- which makes them ideal for stand-alone connected devices, like 4G smartwatches, cameras, and autonomous drones. Qualcomm claims that its Snapdragon Wear chipsets already power over 80% of Android Wear devices worldwide, and it's been testing out autonomous drones with AT&T.
However, analysts expect Qualcomm's revenue and earnings to respectively fall 3% and 4% this year due to rising competition in the mobile chip market, regulators and OEMs challenging its high-margin wireless licensing fees, and numerous antitrust probes and lawsuits. But over the long term, Qualcomm could eventually dominate IoT devices just as it dominated smartphones.
Qualcomm currently pays a forward yield of 4%, which it's raised annually for 14 straight years. That dividend is supported by a payout ratio of 71%, and it used up just 56% of its free cash flow over the past 12 months -- which makes it a reliable long-term income play.
The valuations and verdict
Cypress and Qualcomm are both solid dividend stocks that should benefit from the growth of the IoT market. Both stocks are also fundamentally cheap. Cypress' trailing P/E is negative, due to its recent acquisitions, but its forward P/E of 20 remains well below the industry average of 24 for semiconductor makers. Qualcomm's P/E of 19 is even lower.
If I had to choose one of these stocks as my best "IoT dividend" play, I'd pick Qualcomm. Qualcomm faces more near-term headwinds than Cypress, but its long streak of dividend hikes, higher yield, and lower payout ratios all make it a more reliable income play. As for Qualcomm's IoT business, the NXP acquisition should make it the 800-pound gorilla of the industry -- especially in the growing market of connected and driverless cars.