There are plenty of dividend stocks that offer high yields, but those generous payouts often come with big risks. What you want is a high-yield stock that can sustain its dividend under a wide range of scenarios. A fat dividend yield doesn't mean much if an eventual dividend cut sends the stock plummeting, more than erasing all that dividend income.
My two favorite dividend stocks, both of which I own, are International Business Machines (IBM 0.17%) and General Motors (GM -0.44%). These stocks have been knocked down by pessimism, pushing the dividend yields above 4% in each case. And those high-yield dividends are well covered by earnings, meaning that the chance of a dividend cut is slim. Here's why dividend investors should consider adding IBM and GM to their portfolios.
International Business Machines
It wasn't too long ago that IBM was nothing special when it came to dividends. The tech giant has paid quarterly dividends uninterrupted since 1916, and it's now raised that dividend annually for 23 straight years. But for much of the past two decades, the dividend yield has been severely lacking.
That started to change a few years ago when the stock was dragged down by a long period of slumping revenue and profits. As recently as 2014, IBM was talking about earning at least $20 per share in adjusted earnings. This year, the company expects that number to come in at just $13.80 per share. And since peaking in 2011 at $107 billion, IBM's annual revenue has sunk below $80 billion as a result of divestitures, currency effects, and lost business.
With IBM's stock price depressed, the dividend yield has soared. Based on the most recent payment, shares of the century-old company now yield about 4.3%. That's more than double the yield of the S&P 500, and absurdly high given IBM's competitive advantages. The high-yield dividend is also well covered by earnings, accounting for just 46% of adjusted earnings guidance and 48% of free cash flow guidance.
This abnormally high yield presents itself at a time when IBM has reached an inflection point. Revenue began growing again in the fourth quarter of last year, driven by a strong mainframe cycle and continued growth in the cloud computing business. IBM's "strategic imperative" growth businesses are approaching 50% of total revenue, and cloud computing is on its way to becoming a $20 billion annual business.
With IBM trading for barely more than 10 times adjusted earnings, investors get not only a world-class dividend but also the chance at some serious capital appreciation when the market's sentiment on the stock turns. It shouldn't be hard to see why IBM is my favorite dividend stock, bar none.
It may seem downright foolish, with a lowercase f, to invest in General Motors at a time when U.S. auto sales may be peaking, and when tariffs and trade wars loom. But if you're a long-term investor, able to ignore the market's gyrations, GM is a high-yield stock worth owning.
Shares of GM yield about 4.3%, and the dividend eats up just 25% of the company's expected adjusted earnings for 2018. That earnings guidance has come down this year, which is a reflection of higher commodity costs and currency effects. I wouldn't be surprised if GM's earnings have peaked for the time being, given the headwinds the company is facing. But there's plenty of room for earnings to slump before the dividend payment becomes a problem.
In the long run, the existential threat of self-driving cars flipping the car ownership model on its head would seem to doom GM as an investment. But GM has its own horse in that race with Cruise, a business that's now valued at $11.5 billion after a massive investment from SoftBank. And given the problems Waymo is having with its self-driving cars dealing with simple situations like crossing intersections, I don't think the era of widespread car ownership is going to end anytime soon.
There are plenty of reasons to avoid GM stock. A reason to buy it is because most of those reasons involve short-term issues or overblown concerns. With a high yield and a conservative payout ratio, GM earns its No. 2 spot on my list of top-notch dividend stocks.