Dividend stocks are an alluring investment amid an environment of rising prices, providing a hedge against inflation. Two attractive dividend-paying stocks include IBM (IBM -0.89%) and AT&T (T 1.30%).
Both are well-known companies with excellent dividend yields. IBM's yield is 4.9%, while AT&T is at 5.7% at the time of this writing.
But there's more to picking a dividend stock than yield. A key factor is whether the dividend is sustainable. For example, after the pandemic caused widespread business closures in 2020, several renowned companies, including Walt Disney, stopped paying dividends.
Dividend sustainability is particularly important when considering an investment in IBM or AT&T. Both spent the last few years undergoing significant changes to turn around struggling businesses.
Understanding the state of each company today is important to determining which to invest in. Digging into IBM and AT&T reveals that one holds the edge as the better dividend stock.
Image source: Getty Images.
A look at IBM
IBM is a revitalized organization in 2022. After experiencing a 3% year-over-year revenue decline in 2019, Big Blue made substantial changes to realign itself to focus on the high-growth field of cloud computing.
IBM promoted its head of cloud services to CEO in 2020 and spun off its IT managed-services business into a separate public company, Kyndryl Holdings, last November. After these changes, the new IBM saw 2022's first-quarter revenue grow 8% year over year to $14.2 billion after adjusting for the Kyndryl separation.
Its cloud revenue in particular is exhibiting strong growth. It was $5 billion in the first quarter, up 14% year over year, and $20.8 billion over the trailing 12 months, a year-over-year increase of 17%.
This cloud income is complemented by IBM's consulting division, which generated $4.8 billion in the first quarter, a 13% year-over-year increase. This division counts the top 10 global banks, national governments, telecoms, and automotive companies as customers.
The new IBM expects revenue growth of around $3 billion per year through 2024. In addition, the company's long history of dividend payments stretches back to 1916. It also has an impressive track record of raising its dividend; this year brought the 27th consecutive annual dividend increase.
A look at AT&T
Like IBM, AT&T experienced a tremendous business transformation in recent years. The telecom spent billions to acquire entertainment companies in an effort to build a media empire. This buried AT&T in substantial debt just as the company needed to spend billions to implement its 5G wireless network.
Consequently, after current CEO John Stankey took over in 2020, AT&T divested its media acquisitions, culminating in its WarnerMedia entertainment division merging with cable TV company Discovery to form Warner Bros. Discovery in April.
With WarnerMedia revenue gone, AT&T reduced its annual dividend from $2.08 per share to $1.11. But the nearly 50% reduction means the company can maintain its track record of more than 30 years of dividend payments while investing in its nascent 5G network and paying down debt.
Under Stankey, AT&T's telecommunications business is experiencing a resurgence. Last year, it had 3.2 million net additions among postpaid phone subscribers (its most valuable customer segment), more than the previous 10 years combined. This success carried into the first quarter of 2022 with 691,000 postpaid net additions, the highest first-quarter total in over a decade.
AT&T's customer transition to 5G is still in the early stages, creating the potential for years of revenue growth. That said, with inflation running high, chief financial officer Pascal Desroches stated on June 14 that the company is unlikely to repeat 2021's postpaid subscriber growth in 2022.
A sustainable dividend?
A key indicator of a company's ability to maintain dividends is free cash flow (FCF). In the first quarter, IBM generated $1.2 billion in FCF, but it paid out $1.5 billion in dividends. On the surface, this looks unsustainable, but a single quarter isn't indicative of a trend. In IBM's case, the first quarter historically represents only about 12% of the company's annual FCF.
Moreover, IBM expects its newly transformed business to generate a cumulative $35 billion in FCF between this year and 2024. So the company's anticipated FCF over the next few years should comfortably cover dividend payments.
Like IBM, AT&T's first-quarter FCF compared to dividend payments looks concerning at first glance. AT&T paid out $3.7 billion in first-quarter dividends while generating $700 million in FCF.
But the first quarter included WarnerMedia costs and dividend payments before the dividend was cut. When looking across a full year, AT&T expects annual dividend payments of about $8 billion while generating FCF in the $16 billion range this year, and $20 billion in 2023.
So IBM and AT&T can maintain their dividends. But while AT&T can generate more FCF than IBM, it operates in a saturated U.S. telecom market where 97% of adults own a mobile phone. This means AT&T's revenue growth relies on maintaining its customers and nudging them to upgrade to 5G, which could prove challenging with inflation running hot.
Meanwhile, IBM has the cloud computing industry's growth as a tailwind, with the industry forecast to increase from $706.6 billion in 2021 to $1.3 trillion in 2025. The secular trend of cloud computing combined with IBM's long track record of rising dividend payments gives the edge to Big Blue, making it the better dividend choice.
