Investors tend to ignore tech stocks when looking for passive income. Many growth tech stocks tend to reinvest in themselves and thus attract investors who hope to benefit from outsized returns.
However, many tech companies have existed for decades, adopting dividend policies as they mature. Two of these companies, International Business Machines (IBM 2.19%) and Verizon (VZ -1.04%), pay dividends well above the S&P 500 average of 1.7%, though well below the current 9% inflation rate.With these challenges, the question for investors is which passive income tech stock will likely serve them better?
The case for IBM
After years of sluggish growth, IBM reinvented itself again when it bought Red Hat for $34 billion. With this move, IBM has transformed itself into a cloud stock.
It has built on that move by acquiring over 20 smaller companies since the former head of the cloud and cognitive software segment, Arvind Krishna, became CEO in April 2020. The spin-off of its managed infrastructure segment into Kyndryl also gave IBM more latitude to focus on the cloud.
With that move into the cloud, it faces more competition from the likes of Amazon, Microsoft,and Alphabet. Still, the capabilities of Red Hat could help make it a leader in the hybrid cloud space. Mordor Intelligence forecasts a compound annual growth rate (CAGR) of 21% in the hybrid cloud market through 2027, giving IBM the potential to soar in 2022's second half and beyond.
That growth may also appeal to income investors who want IBM to keep its Dividend Aristocrat status. Last April, IBM increased its annual dividend to $6.60 per share, the 27th consecutive year that IBM hiked its payout. At current prices, this amounts to a 4.8% cash return.
Still, its annual dividend only increased by $0.04 per share, less than 1%. Moreover, in 2021, its capital expenditure (CapEx) was a comparatively modest $2.4 billion. Still, IBM dealt with the cost of spinning off Kyndryl. Consequently, its $6.5 billion in free cash flow in 2021 barely covered the $5.9 billion in dividend costs for that year. Additionally, buying Red Hat took its debt to elevated levels. While debt has fallen since 2019, it currently holds $54 billion in total debt compared to about $19 billion in stockholders' equity.
However, the company believes it can generate $35 billion in free cash flow in the 2022 to 2024 time frame. With the company on track for around $6 billion in dividend costs this year, that should hold the payout in good stead. If trends continue, IBM will probably continue the payout hikes and may increase the dividend at a faster pace.
Why income investors may choose Verizon
Despite IBM's potential, Verizon seems to outperform it as an income stock on many levels. Verizon is one of only three nationwide 5G providers in the U.S. Also, it has won the most J.D. Power awards on network quality for 28 years in a row, giving it an advantage within its industry.
Verizon also appears to operate in a faster-growing industry. Grand View Research forecasts a CAGR of 52% for the global 5G services market.
Finally, it offers an annual payout of $2.56 per share, taking its cash return to 5.1%. While it is not a Dividend Aristocrat, Verizon has hiked the dividend annually since 2007. Also, in 2021, its $19.3 billion in free cash flow financed $10.4 billion in dividend costs and left significant amounts of cash applicable to other purposes.
Unfortunately, it may need that cash more than IBM. Maintaining its top rating meant it spent $20.3 billion in CapEx, an amount consistent with spending in previous years and more than eight times IBM's CapEx spending. It also had to pay $53 billion in 2021 for licensed spectrum, a type of radio frequency-related "real estate" that aids in network operations.
That outlay took Verizon to $151 billion in total debt, a crashing burden and potential threat to the dividend given Verizon's $83 billion in stockholders' equity. This is particularly concerning since its peer AT&T surrendered its Dividend Aristocrat status last year amid heavy debts.Such concerns could temper its tremendous potential in 5G services.
IBM or Verizon?
In the end, Verizon appears positioned to better serve passive income investors.
Still, deciding between these dividend stocks is not an easy task. Both IBM and Verizon hold heavy debt burdens that potentially threaten their payouts. Also, both companies' minuscule payout hikes will not hearten investors in an inflationary environment. Additionally, IBM has significantly lighter CapEx costs, and the Aristocrat status is an added incentive to continue payout hikes.
Nonetheless, unlike IBM, Verizon leads its peers in quality, and its industry holds the potential for more rapid growth. Verizon also holds less debt relative to its stockholders' equity. Such factors may ultimately give Verizon's dividend an added edge.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Will Healy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Microsoft. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.
