When looking for dividend-paying stocks, many investors look for the highest yield. But solely focusing on the size of the payout can mean missing some of the best dividend stocks out there -- specifically, those growing businesses with the ability to increase (and thus compound) your payday over time. The technology sector harbors some great names on this front.
Three potential tech companies that are worth buying stock in right now are Comcast (CMCSA -0.33%), Broadcom (AVGO -3.49%), and IBM (IBM -0.35%). Here's why.
1. Comcast: A main course of communications with a side of travel rebound
Though it may not be everyone's favorite internet service provider, Comcast has been a steady and growing business for years. The stock price is up over 350% over the last decade, as is the dividend payout. And though shares tout an annual yield of only 1.8% as of this writing -- including a 9% dividend increase after the fourth quarter 2020 report -- there's lots of room for it to go higher in the years ahead.
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As a refresher, Comcast reports in three basic segments: Cable Communications, NBCUniversal, and Sky (the European broadcast network it acquired a couple of years ago). This is no perfect business. Cable TV cord-cutting has been a serious problem for years and continued in 2020. And the pandemic wreaked havoc on NBCUniversal's theme park and theatrical movie release segments. All told, though, last year could have been much worse. Total revenue fell just 5% from 2019.
The secret? Comcast reported some of the highest rates of net new high-speed internet subscribers in a long time. And with work-from-home a thing now, it's unlikely these new subscriptions will suddenly reverse course. Add to that lots of new additions to Comcast's mobile phone service (it licenses network use from Verizon Communications) and a new streaming service in Peacock it can use to help offset weakness in cable TV. As the economy gradually reopens in 2021, NBCUniversal will also rebound as theme park visitors slowly return.
All told, I think Comcast is a top stock for 2021. And of course, there's the dividend. Comcast's free cash flow was $13.1 billion in 2020, handily covering the $4.1 billion paid out in dividends last year. With free cash flow poised to rally as effects of the pandemic ease and the stock trading for 20 times that metric, I think Comcast's long run of positive shareholder returns will continue.
2. Broadcom: The semiconductor cycle's winter gives way to summer
One of the world's largest semiconductor companies, Broadcom has run up against numerous headwinds in recent years. As chip demand is cyclical, a normal slowing in sales that started in 2018 was exacerbated by the U.S.-China trade war. Then, of course, COVID-19 came. Broadcom was able to stay in growth mode throughout with a few infrastructure software acquisitions (which now make up about one-quarter of revenue), but the company's bread-and-butter chip segment struggled.
But the long and cold drought has come to an end for Broadcom's largest division. Chip revenue rose 17% during its fiscal 2021 first quarter (ended Dec. 31). Paired with a 5% increase in software, Broadcom's total haul rose 14% from a year ago, and management thinks semiconductor demand will lead to a similar pace of growth for the rest of this year. Strong demand and lingering issues from the trade war have led to a shortfall in global supply, but Broadcom has been disciplined with its supply chain and is experiencing few disruptions in getting hardware to its customers in greatest need.
And since this is a dividend discussion, free cash flow is again worth focusing on here -- and Broadcom is a standout in this department. Profitability has been rising for years as the company gets more efficient, and the inclusion of software has helped a great deal in this regard. To wit, free cash flow rose 35% year over year in Q1 to $3 billion. Payment of the dividend (currently yielding 3.3%) ate up only half of that free cash flow.
There's a lot to like about Broadcom. Its hardware is powering key technologies like 5G mobile networks and data centers -- end-markets that will be in high demand for years. Forecasting strong growth in 2021, Broadcom stock looks like a value at just 15 times trailing 12-month free cash flow.
3. IBM: Get paid while you wait for the spinoff
While Comcast and Broadcom have been steadily growing businesses, IBM has been in a slow but steady decline. Not exactly the kind of business I described in the intro, and the 5.3% dividend yield reflects this situation.
But hidden beneath IBM's struggling legacy IT segment is a growing cloud computing leader -- headed by Red Hat, which IBM acquired back in 2019. In fact, IBM's cloud revenue increased 19% in 2020 and was one-third of the total, though it was offset by weakness elsewhere. Total revenue and free cash flow declined 5% and 9%, respectively. However, IBM announced last autumn it would complete a spinoff of its managed infrastructure business. This will separate a hefty chunk of the operation that has caused IBM some grief in recent years, allowing it to focus on its higher profit margin cloud business.
This could be a transformational move for the old IT giant. Cloud computing has turned into a business staple that helps enterprises get more efficient, make better use of their data, and innovate like never before. IBM can help on multiple fronts, from actual construction of data centers that power the cloud to design and deployment of applications. And given the scope of its capabilities, the company has been forging new partnerships within the tech sector and has become a facilitator of all sorts of breakthroughs like AI and edge computing (smaller localized data centers closer to end-users).
The divestiture of IBM's legacy managed infrastructure segment should be complete by the end of 2021. Details on the deal are still forthcoming, and there's no promise what the dividend policy will be for the new IBM. But while you wait, the current payout is pretty darn good and used up just over half of free cash flow generated last year. Plus, the stock trades for a paltry eight times trailing 12-month free cash flow. It's a cheap valuation that I think doesn't accurately reflect the upcoming structural changes. I'm holding and looking forward to the leaner and meaner IBM (and cloud computing leader) that will emerge by year-end.
