With interest rates near record lows, it can be tempting for investors to seek out dividend stocks with high yields. Unfortunately, elevated dividend yields often indicate trouble. Big dividend payments today mean nothing if the stock later crashes.
While dividend stocks can be a minefield, there are a few good high-yield options unlikely to disappoint long-term investors. Both telecom giant AT&T (T +1.26%) and tech giant International Business Machines (IBM 0.58%) have been left behind by investors this year, pushing valuations down and dividend yields up. Both stocks now look like great dividend options.
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AT&T
It's rare for shares of telecom giant AT&T to trade at such a beaten-down price as to push the dividend yield above 7%, but a combination of the pandemic and some major mistakes related to the entertainment side of the business has done exactly that. AT&T stock now sports a dividend yield of about 7.2%, just about the highest yield in decades.
There are risks involved with investing in AT&T. The company has accumulated a ton of debt attempting to turn itself into an entertainment giant. That strategy hasn't exactly been a home run. AT&T had $153 billion of debt at the end of the third quarter, and it's been losing premium TV subscribers at an alarming pace. The company has been trying to sell DIRECTV, which it acquired in 2015 for $49 billion, but bids so far are reportedly around $15 billion.
AT&T's massive acquisition of Time Warner isn't as much of an unmitigated disaster as DIRECTV, but the company has a lot of work to do to become a major player in the streaming market. HBO MAX combines HBO and other Time Warner content, but the service has been slow to gain subscribers compared to market leader Netflix and rising star Disney.
The good news is that AT&T's dividend is well supported by the cash flow from its core wireless business. That business is doing just fine. The number of wireless subscribers has been rising in recent quarters, and AT&T expects to generate around $26 billion of free cash flow both this year and next. The dividend is expected to eat up less than 60% of that cash flow, with plenty left over to pay down the debt.
With a market capitalization of just over $200 billion, AT&T stock trades for less than 8 times free cash flow. AT&T's strategy has been questionable over the past few years, and the massive debt pile is a monument to the mistakes the company has made. But with pessimism having pushed the stock price down so far, and driven the dividend yield up so much, now's the time to buy AT&T for the long haul.
International Business Machines
Shares of IBM have been beaten down for years as investors refused to buy into the company's transformation story. To be fair, IBM has struggled with slumping revenue and profits as it shifted from legacy businesses to high-growth areas like hybrid cloud computing and artificial intelligence. The pandemic hasn't helped, with weak IT spending from some industries hurting IBM's results.
IBM stock currently sports a dividend yield of around 5.2%. The rally in tech stocks following the pandemic-driven sell-off in March did not extend to IBM; the stock is down around 7% for the year. Based on the average analyst estimate for 2021 earnings, shares of IBM trade at a price-to-earnings ratio below 11.
While IBM has had a tough time adapting over the past few years, the company is now all-in on hybrid cloud computing. IBM paid $34 billion for open-source software provider Red Hat in 2019, and it plans to spin off its managed infrastructure services business by the end of 2021. These two moves accelerate IBM's hybrid cloud strategy. Red Hat's OpenShift container platform and Enterprise Linux operating system add some firepower to IBM's software portfolio, and the spin-off will free up resources for faster-growing businesses like cloud computing.
Certainly, IBM is a stock that requires patience. But for bargain hunters looking for a sky-high dividend yield who are willing to wait for IBM's strategy to bear fruit, it's hard to find a better dividend stock right now.
