International Business Machines Corporation (IBM) probably needs little introduction for most investors. It is the largest information technology or ‘IT’ services company. IBM also has over 90% market share in mainframes and is a major player in middleware. Recently, the company raised the regular quarterly cash dividend albeit only by 0.6%. But still, this represented the 25th consecutive year of increases making IBM a Dividend Aristocrat. Notably, there are only 66 Dividend Aristocrats at the moment, which places IBM in a select crowd. IBM is also on the List of the Dogs of the Dow in 2020. Further, IBM is yielding over 5%. It is one of the few stocks with a yield this high but still decent dividend safety metrics. I view IBM as a long-term buy for those seeking income and dividend growth due to the combination of yield and entrance into the Dividend Aristocrat club.
Overview of IBM
IBM is a global information technology company that provides integrated enterprise solutions for software, hardware, and services. IBM’s focus is large, multi-national customers and governments, for which it runs mission critical systems. In the services business, IBM is the world’s largest IT provider. In software, IBM’s software business is mostly middleware, which is the software layer that connects applications and devices to each other. In hardware, IBM sells the z15 mainframes, storage, and the Power-based servers. IBM generated annual revenue of ~$77 billion in 2019.
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IBM’s Top Line Struggles
IBM top line struggles are well documented. Revenue is down from approximately $105 billion in 2011 to $76 billion in 2019. The company has exited several business lines including PCs and semiconductor chips in the past several years. But arguably the main issue from IBM is that the nature of IT is changing. Enterprise customers are moving to cloud-based architectures to lower costs. IBM is arguably behind the three market leaders which are AWS by Amazon (AMZN), Azure by Microsoft (MSFT), and Google (GOOG).
Is Hybrid Cloud and a New CEO the Answer?
IBM is in the middle of a transformation. The former CEO bought RedHat for $34 billion to accelerate efforts in making IBM a major player in enterprise hybrid cloud. Hybrid cloud is computing and storage infrastructure that is arranged in a configuration of private cloud and public cloud. IBM also has a new CEO who previously ran IBM’s cloud and cognitive services business. Additionally, IBM has a new President, who was the former CEO of RedHat. Before COVID-19 IBM’s cloud-based revenue was growing at a double-digit rate. However, the jury is still out on whether or not IBM will succeed and drive top line growth over longer term since competition is stiff.
IBM New Dividend Aristocrat – Income and Dividend Growth
For investors interested in income and dividend growth IBM pays an annual forward dividend of $6.52 and is yielding approximately 5.5% as of this writing. IBM is now a Dividend Aristocrat. The yield was over 6% during the depths of the market downturn caused by COVID-19. The current yield is much higher than the ~2.0% offered by the S&P 500 index. It is also much higher than conventional higher yielding stocks such as utilities and telecoms. Further, the yield is much higher than some real estate investment trusts or ‘REITs’.
Notably, IBM’s trailing dividend safety metrics are fairly decent despite the high yield. In 2019, the payout ratio was about 50%. The dividend is also safe from the perspective of cash flow. In fiscal 2019, free cash flow was $12,484 million. The dividend required $5,707 million giving a dividend-to-FCF ratio of roughly 46%. I used TIKR* to obtain the data for the dividend safety analysis. Granted, COVID-19 will provide some headwinds to earnings and cash flow in 2020 and possibly into 2021. This may put some pressure on the dividend in 2020. But as global economies reopen then sales, earnings, and cash flow should recover.
IBM is probably slightly undervalued at the moment based on reduced consensus 2020 earnings of $11.09 per share. At the current stock price IBM trades at a forward price-to-earnings ratio of about 10.5. This is slightly below the trailing 10-year multiple of about 12X. I view the stock as a long-term buy.
Disclosure: I am long IBM.
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.