AT&T (T +0.22%) and IBM (IBM 0.81%) were once both popular dividend stocks. Both blue chip companies paid out high yields, had sustainable payout ratios, and raised their dividends every year.
However, AT&T and IBM have both underperformed the S&P 500 over the past five years. After factoring in reinvested dividends, AT&T generated a negative total return of 10%, while IBM generated a positive total return of just 10%. The S&P 500 delivered a total return of nearly 130% during that period.
Let's see why AT&T and IBM have been such disappointing investments, why the two companies face similar challenges, and if either laggard will become a decent dividend stock again in the future.
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AT&T and IBM's past failures and future plans
AT&T and IBM have both struggled to grow in recent years. AT&T grappled with the sluggish growth of its wireless segment and its ongoing loss of pay TV subscribers, and it tried to solve those problems with its debt-fueled acquisitions of DIRECTV in 2015 and Time Warner in 2018.
But buying DIRECTV merely increased AT&T's exposure to the dying pay TV market, and it struggled to manage Time Warner's massive media business and expand its streaming media services. The pandemic exacerbated the pain by disrupting its production and releases of new shows and movies.
AT&T abandoned both misguided bets earlier this year. It spun off a 30% stake in DIRECTV (including AT&T TV and U-verse), and announced it would spin off Time Warner (WarnerMedia) into a separate company via a merger with Discovery by mid-2022.
Meanwhile, IBM has struggled with declining demand for its IT services, business software, and hardware. As its peers expanded their cloud businesses, IBM focused on cutting costs, divesting businesses, and buying back shares to boost its earnings per share as its revenue growth stalled out.
IBM tried to reverse that trend with a long series of acquisitions over the past decade, including SoftLayer in 2013 and Red Hat in 2019. It also plans to streamline its business by divesting its managed infrastructure services unit into a separate company, Kyndryl, by the end of 2021 to prioritize the expansion of its higher-growth hybrid cloud and AI businesses.
Leaving the Dividend Aristocrats behind
AT&T and IBM are both Dividend Aristocrats -- elite members of the S&P 500 that have raised their payouts for at least 25 straight years. However, both companies will likely leave that club after their upcoming spinoffs.
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AT&T pays a forward yield of 7.6%, but it expects to spend just $8 billion of its annual free cash flow on dividends after the spinoff, compared to nearly $15 billion in 2020, which implies its yield will drop to 3%-4%.
AT&T claims the cut is justified because its existing shareholders will receive new shares of the WarnerMedia spinoff. However, that new company will likely spend most of its cash on new media projects and its streaming ecosystem, so it probably won't pay a dividend.
IBM currently pays a forward yield of 4.7%, and has declared the two separated companies will pay a "combined quarterly dividend that is no less than IBM's pre-spin dividend per share." However, the "new" IBM might reduce its dividend to focus on new investments, while Kyndryl might pay higher dividends from its slower-growth businesses.
The growth rates and valuations
AT&T's revenue and adjusted earnings fell 5% and 11%, respectively, in fiscal 2020. Its wireless business stabilized and HBO Max continued to gain more subscribers, but the weakness of DIRECTV and pandemic-related disruptions at WarnerMedia offset those gains.
Analysts expect AT&T's revenue and earnings to rise 3% and 6%, respectively, this year against easy year-over-year comparisons.
IBM's revenue and earnings fell 5% and 32%, respectively, in fiscal 2020 as the softness of its legacy businesses throughout the pandemic offset the growth of its newer cloud-based businesses and Red Hat. Excluding its upcoming spinoff, analysts expect its revenue and earnings to rise 2% and 24%, respectively, this year as it also faces easier year-over-year comparisons.
Both stocks look cheap: AT&T trades at nine times forward earnings, while IBM has a forward P/E ratio of 12. But it's also easy to see why investors aren't willing to pay a premium for either stock.
Is there really a better choice?
I don't like either AT&T or IBM as a dividend investment. But if I had to choose one, I'd stick with IBM. CEO Arvind Krishna, who took the helm last year, has a clearer plan for expanding into the hybrid cloud and AI markets than his predecessors. If his plan succeeds, IBM could potentially carve out a growing niche market between public cloud giants like Amazon and Microsoft.
I'm not as optimistic about AT&T CEO John Stankey's ability to strengthen the company's core wireless business, which faces brutal competition from T-Mobile, or make its new media spinoff a viable competitor to Netflix and Disney.
There are plenty of better dividend tech stocks to choose from, but investors should still keep an eye on AT&T and IBM's upcoming spinoffs and future dividend plans.
