If you were thinking about investing in it, IBM (NYSE:IBM) stock looks fairly cheap right now. Its dividend yield is now very high at 4.6%, assuming its $6.48 annual rate stays unchanged. And now that IBM’s $34 billion purchase of Red Hat has closed, the dividend is looking even more secure.
In a presentation to analysts on Aug. 2, IBM showed that Red Hat would raise IBM’s free cash flow by about half a billion dollars in 2020 and $1 billion in 2021, after interest costs from the purchase.
This is important, since as I pointed out in my previous article on IBM, the company has stopped its buyback program in order to pay down the acquisition debt and maintain the dividend.
IBM’s annual $6.48 per share dividend costs $1.4 billion each quarter, or $5.6 billion annually. In Q2 IBM reported FCF of $2.4 billion, or $9.6 billion at an annual rate. That still leaves $4 billion for IBM to pay down the $34 billion in debt principal that it took on to buy Red Hat.
Dividend Yield Comparison on IBM Stock
Compared to some other large software stocks, IBM’s dividend yield looks very attractive. After all, Microsoft (NASDAQ:MSFT) stock yields 1.3%, Oracle (NYSE:ORCL) yield 1.8%, and Cisco Systems (NASDAQ:CSCO) yields 2.9%.
But, as I pointed out in my previous article, IBM’s dividend growth rate has been slowing. These other stocks have had growing dividends, and they also repurchase their shares. Their buyback yields are also attractive, giving them high total yields.
So, on the pro side, IBM’s high dividend yield is now very secure with the Red Hat acquisition. But don’t expect its dividend rate to increase much, if at all, since IBM now has to pay down its debt.
FCF Yield Comparisons
One bright spot is that IBM sports a very high free cash flow yield compared to its close peers. IBM’s $9.6 billion FCF divided by its $125 billion market value gives IBM stock a 7.7% FCF yield. Microsoft’s FCF yield is 3%, while both ORCL and CSCO stock have a 5.9% FCF yield.
This means IBM’s free cash flow is not being valued as highly as its peers — which makes IBM stock attractive on a relative basis.
International Business Machines Stock has Performed Well
The IBM stock price has risen 24% so far this year. This is better than most of its close peers. MSFT is up 39% YTD, but ORCL is up 19% and CSCO gained 14%. Given that the IBM is relatively undervalued on both a dividend yield and FCF yield basis, it’s realistic to assume that the IBM stock price will continue to perform well.
Meanwhile investors will have fun collecting IBM’s relatively higher dividends. Those dividends are now even more secure with the extra free cash flow that the Red Hat acquisition provides.
Moreover, once IBM has made a dent in its Red-Hat-related debt in several years, you can expect that IBM will resume buying back its shares again. That will have numerous benefits to investors. Moreover it will increase IBM’s overall total yield (dividend yield plus buyback yield).
In sum, IBM stock’s dividend yield looks very attractive here and is much more secure with the Red Hat acquisition.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.
