The low-yield scenario in the fixed-income market has forced many of us to fall in love with the dividend stocks. Many investors would just filter stocks that have the highest dividend yields for portfolio construction. However, the nuanced investors among us will always take the dividend yield with a grain of salt; the smartest income investors always put a lot of focus on a company's ability to sustain the dividend payouts. For this, one has to analyze a company's dividend history, its current market leadership position, its growth prospects, and its ability to generate free cash flows.
I have analyzed the 10 Dogs of the Dow using the above-mentioned criteria. Two stocks in this group stand out as having the ability to be a part of an income portfolio.
First is Intel (NASDAQ:INTC), the king of semiconductor chips, which has a forward annual dividend yield of 3%. The five-year average dividend yield stands at 2.9%, and so does the trailing 12 months dividend yield. The payout ratio is only 34%. With an annual EBITDA north of $23 billion and a total cash of $13.75 billion, the company is in a strong position to keep paying dividends in the years to come. In addition, its free cash flow yield is near 9%. From a financial leverage perspective, the balance sheet is strong as the debt/equity ratio is a mere 16% and the net debt is expected to reach -$8 billion by the end of this year.
Intel reported Q1 2012 earnings that were above Street estimates. Though the stock traded down after the report, it has recovered the losses and is now trading near its pre-earnings report level of $28.50. Management said that smartphones with Intel architecture would be available in Q2 2012. Going forward, this can be a big boost to the company's top line. So far, Intel has not been able to capture growth from the growing mobile sales; however, Intel-based mobile phones will change this scenario. Its server business is also expected to benefit from the growth in emerging markets, especially from China.
Its closest competitors are Advanced Micro Devices (NYSE:ADM) and Texas Instruments (NYSE:TXN). Intel is a clear market leader and beats its peers in market share, margins, growth rates, and returns. Its operating margins of 32% are higher than Advanced Micro's 8%. As far as growth is concerned, both Advanced Micro and Texas Instruments have posted negative revenue growth numbers.
Intel is trading at cheap valuations. Its price-to-earnings ratio (based on 2013 estimates) is only 9 times vs. the peer average of 14 times. Price to operating cash flow is 6 times and the P/E-to-growth ratio is also below 1. On the other hand, Texas Instruments is trading at a PEG ratio of 2.95.
Second is AT&T (NYSE:T), a U.S.-based telecommunication giant that offers a dividend yield of 5.4% and is trading at its 52-week highs. The company is a cash flow machine generating an annual free cash flow of more than $14 billion. This is much more than the $10.5 billion of annual dividends to be paid. Annual cash flow from operations is near $35 billion. Net debt/EBITDA is around 1.5 times and the debt/capital ratio is just 39%.
The company has recently announced its Q1 2012 results. Both revenues and earnings were above estimates. Historically, the margins in the wireless segment have been a key factor for EPS growth. The first-quarter beat was also a result of wireless margins improving by 240 basis points. The stock is also expected to benefit from the growth in ARPU (average revenue per user); for this quarter, ARPU increased from $63.76 (in the fourth quarter of 2011) to $64.46.
This growth in ARPU was a result of higher-than-expected sales of iPhones. AT&T's ARPU is higher than that of Verizon's (NYSE:VZ), at $55.3. Verizon is also trading at a higher forward P/E ratio of 16 times vs. 13 times for AT&T. AT&T's other segments, such as mobile data, are also expected to contribute to the bottom line. Mobile/Internet data revenues are expected to grow by more than 20% due to high mobile data traffic.
Its other competitor, Sprint (NYSE:S), has much lower gross margins of 42% vs. 55% for AT&T. Sprint is not making money and has lost more than $3 billion in the last 12 months.
The company is expected to complete its share repurchase program of $9 billion within this year. AT&T's stock is less volatile in nature and has a beta of only 0.46. A dividend yield of 5.4% along with EPS growth of 8%-10% makes it a safe high-yielding stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.