The downturn fueled by the novel coronavirus has gone from bad to worse as investors fear the potential economic implications of the pandemic. Not surprisingly, the stock market crash of 2020 may tempt investors to pull their money out of the markets to cut their losses. But at the same time, they should keep an eye on certain stocks that are selling at attractive levels now and could turn out to be solid long-term bets.
Microsoft (MSFT 0.37%) and Applied Materials (AMAT 1.46%) are two such stocks. Apart from their sunny long-term prospects, both also pay a dividend that could ensure an income stream in times of volatility. Let's take a closer look.
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1. Microsoft is a bargain right now
Microsoft carries a dividend yield of 1.51%. That might not seem very high, but investors need to keep in mind that the software giant had been growing at a fast clip before the COVID-19 outbreak took hold. Its revenue was up 14% annually in the last reported quarter, while non-GAAP earnings had jumped an impressive 37%.
Microsoft's free cash flow has also been heading north for the past year. All of this bodes well for the company's dividend as its payout ratio of 36% indicates that the payment stream is sustainable. What's more, the company has raised its dividend for the past 16 years. The last hike came in September 2019 when Microsoft increased the quarterly dividend payout by 11%.
The bad news is that Microsoft's business will take a hit on account of the novel coronavirus outbreak. The company recently announced that its personal computing business will turn in a weaker-than-expected performance thanks to slow sales of its Windows software. Microsoft clarified that its other business units won't be affected.
Like many other tech stocks, even Microsoft has pulled back substantially of late. But the good news for investors is that Microsoft stock is now an attractive bargain. Its trailing price-to-earnings (P/E) ratio of 24 is significantly lower than the five-year average multiple of 35. According to analyst estimates compiled by Yahoo! Finance, Microsoft should deliver double-digit earnings growth in the current fiscal year and also in the next one.
The COVID-19 epidemic could hurt Microsoft's projected earnings growth. But the terrific growth of Microsoft's cloud computing and Office 365 businesses looks sustainable for a long time as the global public cloud market is expected to clock mid-teens growth for the next three years, per Gartner.
As Microsoft is outpacing its rivals in the cloud business, it should be able to overcome any short-term headwinds and become a growth stock once again.
2. Applied Materials is confident in its ability to ride out the headwinds
Applied Materials stock has lost over a fourth of its value so far this year, which isn't surprising as the company supplies semiconductor fabrication equipment to chipmakers. After all, chip stocks have been hurt big time by the COVID-19 disease because of the industry's reliance on China. Bernstein analyst Stacy Rasgon estimates 35% of the semiconductor industry's sales come from the Chinese market.
Semiconductor sales are bound to take a hit as demand for products such as smartphones drops as a result of the outbreak. Apple has already reduced its revenue guidance for the ongoing quarter, and so have a number of its suppliers. A report out of China points out that sales of iPhones were down nearly 39% annually in February.
In such a scenario, the demand for Applied Materials' equipment could suffer. However, the company had announced in its most recent earnings conference call (held in February), that it sees robust investment in foundries thanks to the rollout of 5G.
If that's indeed the case, then there is a good chance of Applied Materials stock regaining its mojo when the company releases its next earnings report. Applied Materials investors have another reason to be cheerful as China reports that the COVID-19 disease in the country has reached a peak. A senior medical official from China also claims that the pandemic could be tackled by June if there is a coordinated response by countries across the globe.
All of this suggests that the recent weakness in Applied Materials stock may be temporary. This is why now would be a good time to go long on the stock as it trades at just 15 times last year's earnings. That's lower than Applied Materials' five-year average P/E ratio of 17.5.
What's more, the company has just raised its quarterly dividend by a penny to $0.22 per share, which brings its forward dividend yield to 2.17%. The latest hike is in line with the 5% increase Applied Materials had announced last year.
More importantly, the company's dividend seems sustainable as its payout ratio before the latest hike stood at 20%. If Applied Materials is able to deliver the growth that it's promising, its earnings and free cash flow should keep moving north and support the case for a stronger dividend in the future.
Savvy investors looking for a dividend stock that can also deliver growth should take a closer look at Applied Materials while it trades at attractive levels.
