Companies have a lot of choices to make when the profits roll in. Obviously, investors want their stocks to climb higher over time, and that often requires management plowing more profits back into the business. But companies that pay dividends, especially those in growing tech markets, generally have profitable business models that can deliver growth and income to investors, which is nice to have when the markets get dicey.
Many tech companies are experiencing pressure due to lower demand for consumer electronics, but this is allowing long-term investors to buy industry leaders at high yields and at cheap valuations.
If it were my money, here’s why I would consider buying Taiwan Semiconductor Manufacturing (TSM 0.75%) and HP (HPQ -0.03%).
1. Taiwan Semiconductor Manufacturing
Taiwan Semiconductor Manufacturing is one of the leading chip foundries in which it makes chips for other companies. It’s coming off a strong year of profitable growth, but the weakening demand trends in the chip industry have weighed on the company’s recent quarterly revenue and stock price.
Lower demand for electronic devices has cascaded to lower chip orders, and TSMC is starting to feel the impact. Revenue fell roughly 19% year over year in the most recent quarter. However, TSMC is an extremely profitable business, with an operating margin at 45%. This allows management to continue reinvesting for the long-term growth in advanced processors, including for major customers like Advanced Micro Devices and Nvidia, while paying out around half of its free cash flow in dividends.
Long-term investors can take advantage of Wall Street’s focus on the near term. The stock’s recent dip has only brought the dividend yield up to a more attractive 2.14% — well above the average tech stock’s 1.37% yield.
TSMC is a great income stock to consider for those investors who also want exposure to long-term growth opportunities in high-performance computing, such as artificial intelligence, which is expected to drive more demand over the long term.
In fact, the long-term demand trends in the semiconductor industry make it a great place to look for bargain stocks right now. Last year, Pimco released a report highlighting the undervaluation occurring within the semiconductor industry right now. As more industries across the economy use chips in their business, Pimco expects revenues to be less cyclical over time, which should lead to higher valuations.
This fits TSMC’s forecast for its business. Management is planning to grow capacity over the next few years to prepare for rising demand while staying committed to steadily increasing the dividend.
Investors can currently buy the stock at a modest forward price-to-earnings (P/E) ratio of 16 to go along with an attractive yield. This valuation seems low given the company’s stellar operating performance historically and prospects for above-average growth beyond 2023.
2. HP
Another tech stock paying an above-average yield is HP. The company is experiencing lower revenue from slacking PC and printing demand, but the company generates a healthy amount of profit and has a generous capital-return policy that has even won the investment backing by Warren Buffett‘s Berkshire Hathaway, which disclosed a small stake a year ago.
HP has increased its dividend for 13 consecutive years and paid out half of its free cash flow last year. That brings the dividend yield to 3.5%. While lower revenue caused free cash flow to turn negative in the most recent quarter, I wouldn’t be concerned about HP’s ability to sustain its dividend for a few reasons.
First, management is focused on maintaining a healthy balance sheet by keeping its debt at reasonable levels relative to its annual profitability.
Second, the company is reducing its cost structure, which will ensure that it generates enough cash to reinvest in growth initiatives and sustain dividend payments.
Third, management is allocating capital toward areas that will deliver long-term growth, such as computer peripherals for remote working, collaboration solutions, and shifting its printing business toward a subscription service, where Instant Ink reported a double-digit increase in revenue last quarter with over 12 million subscribers.
HP’s printing and consumer PC business will bounce back. While management doesn’t expect a significant economic recovery this year, company guidance calls for improved business performance on the bottom line in the second half of the year driven by cost-saving initiatives.
HP looks like a steal at these share prices. The stock trades at a forward price-to-earnings (P/E) ratio of just 9, and offers a high-dividend yield and the opportunity to invest alongside one of the greatest investors of all time.
This content was originally published here.
