With the SPDR S&P 500 ETF (NYSEMKT:SPY) yielding barely more than 2% and trading for a historically pricey 24 times earnings, it doesn’t take much looking to find stocks with both higher yields and more tempting valuations. There are plenty of stocks sporting double-digit dividend yields available, but investors shouldn’t take on massive amounts of risk in an effort to chase yield. Instead, the best bet is to focus on good companies trading at attractive valuations that pay fatter dividends than the index. International Business Machines (NYSE:IBM), Qualcomm (NASDAQ:QCOM) and Coach (NYSE:COH) fit the bill.
International Business Machines
While IBM has been paying dividends for over a century, the stock’s yield has been lackluster for much of the past two decades. The company has raised its dividend for 21 years in a row, but it took a decline in the stock price to push the yield up to an attractive level. Today, shares of IBM yield about 3.65%, and the stock is nearly 30% below its five-year high.
On the surface, IBM’s performance has been downright awful. Revenue has slumped for 16 quarters in a row, with a double-digit revenue decline in 2015. Earnings are falling as well, something that dividend investors never like to see. But much of IBM’s lost revenue has been due to changes in currency exchange rates and divestitures of under-performing businesses. Adjusted for those items, IBM’s revenue declined by just 1% in 2015.
These issues hit IBM at the same time that the company is undergoing a transformation, shifting its business toward cloud and cognitive computing. Pessimism related to this transformation has driven the stock down over the past five years, but IBM remains a wildly profitable, and in my opinion misunderstood, company. Even as earnings have declined, the dividend is not in danger. The company expects to earn at least $13.50 in adjusted earnings this year, putting the expected payout ratio at just 41% and the stock’s PE ratio at just 11.3. That’s a bargain in my book, and a lofty dividend yield only sweetens the deal.
Qualcomm is highly dependent on the smartphone market, and the recent slowdown in smartphone sales is certainly bad news for the company. During the latest quarter, Qualcomm reported a 19% year-over-year decline in revenue, while adjusted net income slumped 34%. With numbers like that, it’s no wonder that the stock has tumbled more than 30% over the past two years.
Qualcomm derives most of its profit from licensing key technology, and while that business has suffered in recent quarters along with the chip business, it should continue to generate outsize profits going forward. The stock yields 3.85% following a recent dividend hike, and aggressive share buybacks have been helping to knock down the share count. During the past twelve months Qualcomm produced $6.5 billion of free cash flow, putting the expected payout ratio based on this number at about 49%.
Dividend growth may be slow as Qualcomm adjusts to a sluggish smartphone market, but a high yield coupled with a low valuation makes Qualcomm stock an attractive option. Qualcomm produced $4.66 in non-GAAP EPS in 2015, putting the PE ratio based on this number at just 11.8. Uncertainty has pushed Qualcomm’s stock price down, and dividend investors can benefit as a result.
For much of the past decade, Coach’s handbags have produced incredible margins for the company. Gross margins in the 70s and operating margins in the 30s were the norm. Fashion products like Coach’s handbags, when in demand, are cash cows.
Coach ran into some major problems a few years back. Competition from rivals such as Michael Kors and the company’s decision to transform into a lifestyle brand hurt sales. In fiscal 2015, Coach’s revenue tumbled nearly 13%, and operating margin fell to 14.7%. The company has been reducing its store count in North America and pulling back on promotional activity. If a luxury brand becomes too ubiquitous, charging premium prices becomes more difficult.
The turnaround appears to finally be taking hold, with the company reporting double-digit revenue growth during its latest quarter. Coach yields about 3.5%, and while the payout ratio is high based on recent earnings, those earnings are depressed. Coach has earned $1.40 in GAAP EPS over the past twelve months, putting the payout ratio at very nearly 100%. However, the payout ratio is less than 30% if we assume that Coach can bring its operating margins back to historical. Coach is the riskiest of these three stocks, and there’s a chance that the dividend gets cut if things go wrong. But it appears that the worst is over for the company.
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Timothy Green owns shares of International Business Machines. The Motley Fool owns shares of and recommends Coach and Qualcomm. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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