Income Investors: Ditch Your CDs and Buy These

Casey is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It's frustrating to be a saver right now. The traditional avenues of saving, CDs and U.S. Treasury bonds, offer minuscule yields that are probably negative when adjusted for inflation. A quick check at Bankrate.com shows the best CD yields at 1%. U.S. Treasuries aren't much better: 10-year bonds yield only 1.66%.

Numbers like this can be very discouraging to everyday folks looking to save and put money away. Thankfully, there are plenty of stable, well-known companies with clean balance sheets, which yield nice dividends over 3%. Many are yielding over 4%. This is just something you can't get in the traditional savings market, and if you think about it, they really aren't that much riskier. These companies can offer what bonds and CDs never will - the possibility of a growing dividend.

Today, I'm going to focus on three companies that I believe can be bought now. They are well known and their stock prices are still relatively low. All of them trade at reasonable earnings multiples. Finally, all three are well-managed and have clean balance sheets. I hope you will consider them and add them to you watch list.

Cisco Systems

Dividend Yield: 3.24%

Price/Earnings: 12.0

Cisco (NASDAQ: CSCO) designs, manufactures, and sells internet protocol (IP)-based networking and other communications and IT products and associated services. Its specialty is products for transporting data, voice, and video within buildings, across campuses, and around the world. 

Cisco is part of the "old tech" group, rising stars in the late 1990s. Unlike many of the others, such as Microsoft, Dell and Intel, Cisco still remains both dominant and relevant today. In other words, Cisco's line of business is not one that is in decline.

The chart above shows that Cisco really hasn't done much in months and its valuation is reasonable. But, the most compelling thing about Cisco right now is the steady growth it offers for the patient investor.

Presentation can be found at Cisco Financial Analyst Conference 2012.

Last year was a pretty good year for Cisco, increasing its revenue by a solid 7%. In fact, the company expects this to be a long-term trend in both revenue and earnings per share. The company's goal is compound revenue growth of 5%-7% and earnings per share growth of 7%-9% over the long term.

That earnings growth should translate into dividend growth. Cisco has gotten serious about its dividend starting in 2011, and has increased its payout in 2012 and 2013. This year, it increased the dividend from $0.14 per quarter to $0.17, an increase of over 18%. Going forward, the dividend should grow by at least earnings per share. That should translate to 7%-9% dividend growth over the long term. At that rate, your income will be handily outpacing inflation.

China Mobile

Dividend Yield: 4.02%

Price/Earnings: 10.6x

China Mobile (NYSE: CHL) is the largest telecommunications company in the world, by market cap and subscribers. The stock has actually declined by as much as 15% since the new year, but has since recovered and is now down only about 8%. It's still a good deal, though. 

Right now, China Mobile is a turnaround story. Its plain vanilla voice and SMS business, otherwise known as 2G, is huge and very profitable. Unfortunately, it's been well behind in wireless, mobile data (think smartphones, known as 3G), and on an inferior standard not compatible with many of the big smartphone makers. So, as 3G has taken a greater and greater portion of telecommunications in China, China Mobile has suffered from a combination of lower margins and declining market share.

Thankfully, China Mobile has been working hard to develop a new 4G standard, compatible with globally proven technology. The Chinese government has indicated they could issue 4G bandwidth permits within 2013. In coming years, China Mobile's growth could then look more like China Telecom's and China Unicom's, both of whom operate on a globally proven standard for their 3G network. In 2012, for example, China Unicom grew its revenue by 19%. In the meantime, China Mobile should continue to grow modestly, as it did in 2012:

Table can be found at 2012 Annual Results Presentation.

Finally, China Mobile offers a balance sheet cleaner than any other major, Western telecom. With a debt / free cash flow ratio at only 0.3 times, and a dividend to free cash flow coverage ratio in the low 50%s, China Mobile is about as safe and secure as you can get. Plus, a dividend still north of 4% will beat conventional savings a few times over. China Mobile will pay you to wait.

AT&T

Dividend Yield: 4.8%

P/E Ratio: 22.2x

AT&T (NYSE: T) is the largest provider of telecommunications services in the United States. Services offered include wireless communications, local exchange services, and long-distance services. Looking at the chart, we can see AT&T stock getting hit hard by an earnings report the Street didn't like. 

Chart can be found at 1Q13 Earnings Conference Call

While earnings had some weak points, they weren't that bad overall. Total wireless revenue growth of 3.4% is led by data revenue (of which 3G smartphones were the driver). Consider also that average revenue per user continues to climb. I would say the quarter was really not too bad. AT&T has what income investors really need - high yield with modest growth.

And, here's another thing to like about AT&T: its dividend is very safe. The dividend / free cash flow ratio is in the mid-50% range, comparable to China Mobile's.

Chart by YCharts

But, there are a few fundamental reasons for caution on AT&T. First is the dividend yield. While 4.8% may seem pretty good, the chart above shows that it has been much higher in the past (due to a lower stock price). Those who want to wait for a higher yield could be forgiven. Also, despite the recent drop, the price to earnings ratio of 22.2 is well above its historical multiple of 18.7.

Still, AT&T's dividend and modest growth are very attractive in this low rate environment. At the very least, you should add AT&T to your watch list.

Conclusion

Traditional savings vehicles, CDs and Treasury Bonds, are a loser's bet at these prices. The little guy can still generate plenty of income in stocks, however, and it doesn't have to be as risky as you may fear. By buying steady, well-managed dividend payers like the ones above, you can actually generate good income from your savings.

Additional sources:

Historical P/E data from F.A.S.T. Graphs

Once a high-flying tech darling, Cisco is now on the radar of value-oriented dividend lovers. Get the low down on the routing juggernaut in The Motley Fool's premium report. Click here now to get started.


Casey Hoerth has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of China Mobile. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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