Chipmakers Intel (INTC 0.81%) and Qualcomm (QCOM 1.07%) are often mentioned as sound income-generating plays on the semiconductor sector. Intel pays a forward dividend yield of 2.5%, and has raised that dividend annually for the past two years. Qualcomm pays a higher forward yield of 3.4%, and it's hiked that payout annually for 15 straight years.
At first glance, Qualcomm's higher yield and longer streak of dividend hikes make it seem like a better income investment. But if we dig deeper, we'll realize that Intel is actually a better dividend stock than Qualcomm for four simple reasons.
1. Lower payout ratios
Investors should always check the payout ratios -- the percentage of a company's earnings or free cash flow spent on dividends -- to gauge a dividend's sustainability. If either percentage exceeds 100%, the dividend could be cut.
Over the past 12 months, Intel spent 36% of its earnings and 43% of its FCF on dividends. Qualcomm spent 132% of its earnings and 81% of its FCF on dividends during the same period. Both of Qualcomm's ratios are at historic highs, due to steep declines in its net income and FCF over the past year:
2. Better earnings and FCF growth
Here's how much Intel's net income and FCF rose during the same period:
Looking ahead, analysts expect Intel's revenue and earnings to grow 4% and 20%, respectively, this year. Qualcomm's revenue and earnings are expected to fall 2% and 17%,respectively.
This means that the trends depicted in these two charts should persist for the foreseeable future, making Intel's lower yield seem much safer than Qualcomm's higher one.
3. Fewer headwinds and more tailwinds
Qualcomm's top- and bottom-line growth is weighed down by several major headwinds. Its chipmaking business, which generates most of its revenue, faces competition from cheaper rivals like MediaTek and first-party chipsets from major OEMs like Huawei.
Its higher-margin wireless patent licensing business, which generates most of its profits by collecting royalties from all handset makers worldwide, faces litigation and probes worldwide from companies and government regulators that claim that its licensing fees (up to 5% of the wholesale price of a device) are too high.
Apple (AAPL -0.50%), which is suing Qualcomm over those fees and unpaid rebates from a prior exclusivity deal, also suspended all licensing payments to Qualcomm. All this drama is casting a long shadow over Qualcomm's planned takeover of NXP Semiconductors (NXPI 1.53%).
Intel is faring much better with less drama. Sales of its PC and data center chips are still rising, albeit at single-digit rates. However, its smaller Internet of Things (IoT), non-volatile memory, and programmable chips businesses are all still generating double-digit sales growth. Looking ahead, Intel plans to expand those businesses to offset the slower growth of its PC and data center businesses.
Intel also has plenty of irons in the fire for 2018 and beyond. It's introducing its next-generation 10nm chips for PCs and data centers, investing in discrete GPUs, developing new memory chips with Micron, and expanding its presence in the automotive market with new computer vision chips and partnerships. But more importantly, it's not being pummeled by probes and lawsuits like Qualcomm.
4. Cheaper valuations
Intel's stock has rallied more than 20% this year, while shares of Qualcomm have stayed roughly flat. Yet Intel still trades at just 17 times earnings, compared to the industry average of 26 for semiconductor makers. Qualcomm has a much higher P/E ratio of 25.
Looking ahead, Intel trades at 14 times next year's earnings, while Qualcomm has a forward P/E of 17.
The key takeaway
Investors should always look beyond a stock's yield and history of dividend hikes to understand its sustainability as an income investment. Qualcomm initially looks like a better dividend play than Intel, but the latter's lower payout ratios, stronger earnings and FCF growth, and rosier outlook make it a much better dividend stock than Qualcomm.