Income

Which Is Better Passive Income Tech Stock: IBM or Verizon?

Investors tend to ignore tech stocks when looking for passive income. Many growth tech stocks tend to reinvest in themselves and thus attract investors hoping for outsized returns.

However, many tech companies have been around for decades, adopting dividend policies as they mature. Two of these companies, International Business Machines (IBM 0.62%) and Verizon (VZ 1.05%)pay dividends well above the S&P500 average of 1.7%, well below the current inflation rate of 9%. With these challenges, the question for investors is, which passive income tech stock is likely to serve them best?

The case of IBM

After years of slow growth, IBM reinvented itself again by buying Red Hat for $34 billion. With this move, IBM has transformed itself into a cloud stock.

It has built on that move by acquiring more than 20 small businesses since former cloud and cognitive software segment head Arvind Krishna became CEO in April 2020. The split of its managed infrastructure segment into Kyndryl also gave IBM more leeway to focus on the cloud.

With this move to the cloud, it faces more competition from Amazon, Microsoftand Alphabet. Still, Red Hat’s capabilities 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 the second half of 2022 and beyond.

This growth may also attract income investors who want IBM to maintain its status as a dividend aristocrat. Last April, IBM raised its annual dividend to $6.60 per share, the 27th consecutive year that IBM has raised its payout. At current prices, this equates to a cash return of 4.8%.

Yet its annual dividend has only increased by $0.04 per share, or less than 1%. Additionally, in 2021, its capital expenditure (CapEx) was a relatively modest $2.4 billion. Still, IBM picked up the cost of Kyndryl’s spin-off. Consequently, its $6.5 billion in free cash flow in 2021 barely covered the $5.9 billion in dividend costs for that year. Additionally, the purchase of Red Hat drove its debt to high levels. Although debt has decreased since 2019, it currently holds $54 billion in total debt, compared to about $19 billion in equity.

However, the company estimates that it can generate $35 billion in free cash flow between 2022 and 2024. With the company on track for around $6 billion in dividend costs this year, that should keep the payout in good place. If trends continue, IBM will likely continue payout hikes and may increase the dividend at a faster pace.

Why income investors can choose Verizon

Despite IBM’s potential, Verizon appears to outperform it as a revenue stock on many levels. Verizon is one of only three nationwide 5G providers in the United States. Additionally, it has won the most JD Power awards for grid quality for 28 consecutive years, giving it an edge in its industry.

Verizon also appears to be operating in a faster growing industry. Grand View Research predicts a CAGR of 52% for the global 5G services market.

Finally, it offers an annual payout of $2.56 per share, bringing its cash yield to 5.1%. While not a dividend aristocrat, Verizon has raised the dividend every year since 2007. Additionally, in 2021, its $19.3 billion in free cash flow funded $10.4 billion. dollars of dividend costs and left large sums of cash applicable for other purposes.

Unfortunately, it may need that money more than IBM. Maintaining its top rating meant it had spent $20.3 billion on 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 “real estate” that facilitates network operations.

The outlay brought Verizon to $151 billion in total debt, a crushing burden and potential dividend threat given Verizon’s $83 billion in equity. This is all the more worrying as its counterpart AT&T gave up its status as a dividend aristocrat last year amid heavy debt. Such concerns could temper its enormous potential in 5G services.

IBM or Verizon?

Ultimately, Verizon seems positioned to better serve passive income investors.

Still, choosing between these dividend-paying stocks is no easy task. IBM and Verizon both have heavy debts that potentially threaten their payments. Moreover, the tiny increases in payouts from both companies will not be encouraging to investors in an inflationary environment. Additionally, IBM has significantly lighter CapEx costs, and Aristocrat status is added incentive to pursue payout increases.

Nevertheless, unlike IBM, Verizon leads its peers in terms of quality and its industry has the potential for faster growth. Verizon also holds less debt relative to its equity. These factors may ultimately give Verizon’s dividend an added edge.

Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Will Healy has no position in the stocks mentioned. The Motley Fool owns and recommends Alphabet (A shares), Alphabet (C shares), Amazon and Microsoft. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.