One could never confuse International Business Machines Corp. (NYSE:IBM) with Tesla Motors Inc (NASDAQ:TSLA) or even Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) for that matter. However, those looking for income in 2017 should put aside all the negativity that has followed IBM stock in recent years and add it to your portfolio.
Here’s why.
The key to any good dividend stock is consistently growing dividends. IBM has increased dividends for 21 consecutive years; in the last five years, International Business Machines has averaged annual dividend growth of 13.4%, a positive sign for anyone looking for yields of 3% or higher.
IBM stock currently yields a healthy 3.3% despite its stock being up 21% year-to-date through Dec. 27.
It’s especially positive given how much free cash flow the company has been allocating toward share repurchases in recent years. Since 2012, it has reduced its share count by 16.5% to 964 million shares. During those three years, it repurchased $32.2 billion of its stock and paid out another $13 billion in dividends representing 112.4% of its cumulative free cash flow.
It’s no secret, then, why International Business Machines’ revenues shrunk from $102.9 billion in 2012 to $81.7 billion in 2015 and non-GAAP operating earnings declined by 18% over the same period — a lack of investment in research and development and no meaningful acquisitions to speak of has literally been choking the life out of IBM.
However, all that appears to have changed in 2015, providing dividend investors with a renewed interest in IBM stock.
What’s Going on With IBM Stock?
In 2013 and 2014, International Business Machines paid out $18 billion for share repurchases and dividends; in 2015, that dropped to $9.5 billion and so far, through the first three-quarters of 2016, it has shelled out just $6.5 billion, which means the company will have more available to pay down some of its $35.6 billion in long-term debt while still increasing the amount it invests in R&D.
At the height of its free cash flow in 2012, IBM was generating $18.2 billion, paying out 86% of it to shareholders. In 2016, if International Business Machines generates $15 billion in free cash flow and allocates no more than $9 billion to shareholders, it will have paid out just 60% of its free cash flow in the form of dividends and share repurchases, leaving a substantial amount to reinvest in its business.
IBM has been on a journey over the last decade and it still has a lot of work left to regain a prominent place in technology. That said, it has made progress.
In 2005, its gross margin was 40%; today, it’s 11 percentage points higher. A big driver of that is its software and services business, which includes the cloud. While its overall revenues are falling, International Business Machines’ revenue from strategic imperatives established in 2014 such as big data, analytics, cloud, mobile, social and security are rising.
In 2015, revenue from its strategic imperatives increased by 26% excluding currency to $28.9 billion or 35% of its overall revenue. Its cloud revenue increased 57% in 2015 to $10.2 billion. In Q3 2016, its strategic imperatives generated $8 billion in revenue representing 40% of its total for the quarter.
Its financial model for the long-term looks to generate low single-digit revenue growth, mid-single-digit pre-tax income growth and high single-digit earnings-per-share growth through more share repurchases.
Bottom Line on IBM Stock
But before investors worry about share repurchases getting out of hand as they did in 2013 and 2014, IBM’s long-term plan calls for annual dividend increases along with annual share reduction of 2% to 3%.
So, it will be buying back approximately 24 million in IBM stock for the foreseeable future, which works out to $4 billion in annual buybacks — a much more tolerable level.
Although International Business Machines’ transformation might not appear to be moving quickly enough, it has made progress in the past two years generating more of the kind of revenue it needs to in order to grow profitably.
With $10 billion in cash on the balance sheet and free cash flow turning higher, IBM stock is reasonably cheap at the moment despite being within 2% of its 52-week high.
If you’re an income investor you ought to be begging for International Business Machines stock and its 3.3% yield because you won’t get too many deals as good as this one.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
