Good income stocks should be part of any portfolio but particularly those of retirees who can use those quarterly dividend payouts to supplement their Social Security checks. Ideally, you want stocks that will pay you good income now, via dividends, while generating solid long-term returns as well. The more income you generate to supplement Social Security, the less likely you are to avoid draining your retirement accounts and long-term investments.
Two of the best dividend stocks out there are International Business Machines (IBM 1.07%) and T. Rowe Price Group (TROW -0.71%). Both are Dividend Aristocrats, meaning they have increased their dividends annually for at least 25 years, and both have above-average yields.
IBM: Welcome to the club
IBM was the largest company in the world by market cap 40 years ago, and now, it's barely in the top 100 by that same measure. But this former tech giant still offers an attractive dividend. In fact, it joined the Dividend Aristocrats club in 2020.
The company currently pays a quarterly dividend of $1.63 per share, good for an annual yield of 4.9% -- well above the 1.2% median for the technology sector. However, that rich dividend is accompanied by a payout ratio of over 100% as of year-end 2020.
Typically, a "safe" payout ratio falls under 50% to 55% -- anything higher means the company may be paying out too much in dividends at the expense of other investments (not to mention the risk to the dividend itself if earnings deteriorate). At current levels, IBM is actually paying out more in dividends than it is generating in earnings. That's because IBM had a terrible fourth quarter with revenue down 6% year over year to $20.4 billion, while net income declined 63% to $1.4 billion.
But IBM has a bright future as it embarks on a major overhaul of its business. The company is splitting in two and divesting its IT infrastructure unit to focus on cloud computing. This will result in a smaller company but one with more growth potential.
Structural expenses related to the spin-off of its infrastructure services division was a big driver behind the recent earnings decline. IBM also made major investments to scale up its cloud computing infrastructure to prepare for the split. Those expenses will ease in the current year, and analysts expect IBM to report earnings of $11.12 per share in 2021. Based on this figure, the company's payout ratio comes down to a much more reasonable 59%.
"In 2021, the significant changes we have made to focus on hybrid cloud and AI will also begin to take hold," Chairman and CEO Arvind Krishna said on the fourth-quarter earnings call. "At a high level, in 2021, we expect to grow revenues at current spot rates with better performance in the second half than the first half."
Krishna said he expects the company to generate $11 billion to $12 billion of adjusted free cash flow by the end of this year (versus $10.8 billion in 2020), and the company is committed to continue growing the dividend. Its new strategic direction should help.
T. Rowe Price: Dividend royalty
T. Rowe Price Group is an asset management firm and another Dividend Aristocrat with 33 straight years of annual payout increases. The company is solid across the board in all of the metrics used to evaluate and identify solid dividend stocks. The $1.08 per share dividend gives investors a yield of 2.5%, not quite as high as IBM but still better than the average yield for the S&P 500.
Its payout ratio, however, is just 36%. T. Rowe has been a steady performer over the years, through all market cycles. In 2020, it saw assets under management climb 22% to $1.47 trillion. Revenue was up 10% to $6.2 billion as net income jumped 11% to $2.4 billion. And despite the difficult year for mutual funds in general, the company saw net cash inflows into its funds of $5.6 billion.
T. Rowe has been able to consistently outperform many peers and grow its assets thanks to its strong track record -- the company's equity funds have beaten the Morningstar average 85% of the time over the past decade. It recently launched four actively managed exchange-traded funds (ETFs) as it seeks to utilize the companyʻs stock-picking prowess to capitalize on the ETF trend.
And over the past decade, earnings have grown about 15% on an annualized basis. But what makes this such a great dividend stock is the companyʻs efficiency. It has virtually no debt and about $2.2 billion in cash and equivalents with a high operating margin of 48%. This earnings potential and ample liquidity indicate the company is well positioned to extend its dividend-growth streak for years to come.
For many retirees, the extra cash dividends provide can be a valuable supplement to their Social Security payments, part-time paychecks, and any other sources of income. These two Dividend Aristocrats offer both generous quarterly payouts (that should continue to grow every year) and the potential for attractive share price returns as well.