Technology stocks have become an essential part of any diversified portfolio. They have performed so well that Warren Buffett, who avoided tech investing for the longest time, finally jumped on the bandwagon (Buffett held no technology-industry investments until 2010). Today, Apple is the largest holding in the Berkshire Hathaway portfolio.
Contrary to popular belief, not all tech stocks support pricey valuations. Stocks such as AT&T (T -0.89%), International Business Machines (IBM -0.33%), and Qualcomm (QCOM -0.91%) offer bright prospects while still remaining relatively affordable. Let's take a closer look at these three companies.
1. AT&T: Relatively cheap stock with a growing dividend
At first glance, AT&T may look like an unfocused company with massive debt and an unaffordable dividend. In the previous decade, the telecommunications giant spent heavily to buy DirecTV and what became WarnerMedia. It has also invested tens of billions of dollars to build a nationwide 5G network. This has left it with almost $153.4 billion in debt to manage. Consequently, AT&T has struggled to grow its share price.
However, despite appearances, the company's dividend is sustainable and likely to rise every year. At $2.08 per share, the payout yields about 7%. The dividend payout ratio, or the percentage of net income going to the dividend, is currently over 126%.
However, the non-cash charge of depreciation lowered net income significantly. If looking at free cash flow, the $7.59 billion generated in the last quarter easily covers the $3.74 billion in dividend obligations for the quarter.
Moreover, since AT&T is a Dividend Aristocrat, it must raise its dividend annually to maintain that status. To this end, the company borrowed $5.5 billion earlier this year to bolster its cash position. Despite the outsized yield, stockholders will probably see a higher quarterly payout in January.
Furthermore, activist investor Elliott Management has pressured the company to unload assets such as DirecTV to pay down debt. If this happens, it could easily see some multiple expansion beyond its forward price-to-earnings (P/E) ratio of around 9.3. Hence, investors can buy cheaply and collect a massive, growing dividend while they wait.
2. IBM: Became a Dividend Aristocrat this year
Another generous dividend payer is the newest Dividend Aristocrat, IBM. Year 25 of dividend increases took the annual payout of $6.52 per share. This is a yield of just over 5.2%.
In this case, IBM pays a rising dividend for investors to wait for this veteran computer manufacturer's transformation into a cloud computing leader. Arvind Krishna, the former head of the cloud and cognitive software division, took over as CEO in April. He appears to have followed the path of Microsoft, which orchestrated a recovery by promoting its head of cloud computing to the CEO position.
Krishna was instrumental in the company's purchase of Red Hat. He has also made agreements on two additional cloud-related acquisitions in his first three months as CEO.
Admittedly, the pivot into cloud computing was a gamble. Debt rose as high as $73 billion in 2019, a heavy burden when stockholders' equity, the part of the company left after subtracting liabilities from assets, was only $17.6 billion at the time.
Still, the $34 billion cost of Red Hat may have paid off for IBM. Although the company reported an overall revenue decline in the most recent quarter, cloud revenue growth increased by 30% year over year.
Due to the stock's struggles, its forward P/E ratio stands at just over 11. Moreover, since COVID-19 hit some of its divisions hard, it may take time to turn overall revenue growth positive. However, assuming this transformation continues, IBM stock could easily see significant multiple expansion over time.
3. Qualcomm: Set to greatly benefit from strong 5G growth
The picture for Qualcomm continues to improve. Over the last year, the wireless technology giant settled its lawsuit with Apple. Moreover, although a court ruled it a "monopoly," the need for 5G chips has forced a temporary stay of that order.
To be sure, COVID-19 has delayed Qualcomm's recovery. In the most recent quarter, revenue came in flat, and earnings rose by about 8%. The company also guided toward a 15% reduction in handset shipments year over year.
However, the future after the pandemic ends almost could not look more bright. Research & Markets forecasts a compound annual growth rate in the 5G chipset market at 87.8% through 2025! Given that Qualcomm wields monopoly power in this market, that could bode well for shareholders.
Investors may have already taken notice. Following the revenue and earnings beat in its third quarter, Qualcomm stock shot higher by more than 15% in the following trading session.
However, despite this increase, Qualcomm stock trades at a forward P/E ratio of around 19. Analysts forecast 10.7% earnings growth for the current fiscal year. Still, next year when consumers begin to adopt 5G in earnest, they predict profit levels will rise by 62.8%. That growth could mean that investors will not have to wait long for further stock growth.
Moreover, although the dividend does not rise every year, it has moved steadily higher since payouts began in 2003. Today's annual payout of $2.60 per share brings a yield of about 2.4%. This dividend means that investors will receive some level of pay to wait. Still, pent-up demand for 5G could easily mean that that wait may not take a long time.