One of the joys of investing in stocks is watching dividend payments roll in quarter after quarter. Giant capital gains from growth stocks may be more exciting, but a reliable and growing stream of dividend payments, reinvested in more stocks, unleashes the true power of compounding. Dividends have accounted for nearly half of the total return of the S&P 500 Index over the past 25 years. You ignore them at your own peril.
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If you're looking to add some solid dividend stocks to your portfolio, I have a few ideas. International Business Machines (NYSE: IBM), General Motors (NYSE: GM), and Best Buy (NYSE: BBY), all of which I own in my own portfolio, are some of the best dividend stocks available.
A string of bad news
Shares of IBM have dropped about 15% since peaking earlier this year, driven down by a weaker-than-expected first quarter and news that Warren Buffett's Berkshire Hathaway had sold a substantial portion of its stake. IBM's transformation is showing signs of progress, with adjusted earnings expected to return to growth this year. But five straight years of revenue declines wasn't what Buffett was expecting.
Image source: IBM.
This drop in the stock price and a dividend bump in April have pushed IBM's dividend yield up to roughly 4%. The payout ratio sits at 43% based on the company's earnings guidance for this year, giving IBM the ability to continue to raise the dividend going forward even if earnings growth remains sluggish. IBM has increased its dividend for 22 years in a row, putting it three years away from achieving dividend aristocrat status.
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While the pace of IBM's transformation over the past few years has no doubt been frustrating for investors, the company has remained highly profitable even as it invested heavily in growth businesses like cloud computing. Those investments are paying off: The cloud business generated $14.6 billion of revenue over the past year, and IBM's growth businesses now account for 42% of its total revenue. That's not quite enough to offset declining legacy businesses, but the inflection point where revenue begins to grow again should be nearing.
As a dividend stock, IBM offers a 4% yield and a high likelihood of dividend growth. It's not a popular stock at the moment, but the market will probably change its tune once IBM puts an end to its long streak of revenue declines.
A big, sustainable dividend
After years of strong growth, it's becoming increasingly clear that the market for automobiles in the U.S. has peaked. Rock-bottom interest rates have helped automakers sell cars over the past few years, but the prospect of higher rates and a flood of off-lease used cars pushing down prices could spell trouble in the near future.
Image source: GM.
The uncertainty surrounding the automobile market is one reason shares of General Motors trade for just 5.4 times the midpoint of the company's earnings guidance. The market is expecting a big earnings decline, pricing the stock for a disaster scenario. But GM is a far leaner company than it was before the financial crisis. The stock looks cheap under nearly any scenario short of catastrophe.
GM's dividend yield currently sits at 4.5%. More importantly, the payout ratio based on the midpoint of its earnings guidance is less than 25%.It is possible, even likely, that GM's earnings will decline at some point in the next few years. But it would take a massive decline for the dividend to be in danger.
The trajectory of GM's earnings is unpredictable, but with the payout ratio so low, dividend investors have a substantial margin of safety. You shouldn't expect much dividend growth, especially with the company taking advantage of the depressed stock price by buying back shares. But the dividend looks sustainable, making GM a solid dividend stock.
A retail survivor
There are plenty of high-yield dividend stocks in the retail sector, with stock prices pushed down by poor results and competition from e-commerce. Many of those dividends may not be sustainable, so dividend investors should tread carefully. The retail business is undergoing a major disruption, putting dividends that looked safe a few years ago at risk.
Image source: Best Buy.
Best Buy may not look like a great dividend stock, with a dividend yield of just 2.6%. But the company has proved over the past few years that it's capable of going toe-to-toe with online retailers, growing the bottom line despite weak industry demand and inconsistent comparable sales growth. Unnecessary costs have been eliminated, allowing Best Buy to better compete on price, and investments in its e-commerce business have led to consistent double-digit online sales growth.
After a recent dividend increase, Best Buy will pay out $1.36 per share in dividends over the next year, just 35% of its net income in 2016. In addition to a low payout ratio, Best Buy is sitting on $3.9 billion of cash and just $1.3 billion of debt, reinforcing the safety of the dividend. The yield may not be as high as those of IBM or GM, but it should be safe under a wide variety of scenarios, and there's plenty of room for dividend growth if Best Buy can maintain or grow its earnings going forward.
10 stocks we like better than IBM
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Timothy Green owns shares of Berkshire Hathaway (B shares), Best Buy, General Motors, and IBM. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.