IBM Increases Dividend 18%: What You Need to Know

By Markets Fool.com

Source: IBM.

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IBM stock has materially lagged the market lately: Big Blue is down by almost 17% over the past three years, while the S&P 500 index delivered a huge gain of nearly 50% in the same period.

However, cash-flow distributions are pointing in the right direction for IBM, as the company is building an extraordinary track record of dividend growth and consistent share buybacks.Is IBM an underappreciated cash powerhouse or an agonizing tech dinosaur?

IBM: Increasingly Big Money
IBM recently announced a big 18% dividend increase, raising the quarterly payment from $1.10 to $1.30 per share. This was not a one-time event. Far from it: The company has an amazing track record of dividend growth.

IBM has paid uninterrupted dividends since 1916, and it has increased payments for 20 years in a row. Dividends have grown by a double-digit percentage rate for the past 12 years, and payments have doubled in the past five years. The dividend yield stands at nearly 3% after the latest increase. That's quite a respectable level, especially considering IBM's trajectory of dividend growth over the past two decades.

Furthermore, IBM has a big and dynamic share-buyback policy. The company has reduced its outstanding share count by nearly 40% in the past decade. Based on data for the first quarter of 2015, IBM reduced its diluted share count by 5% year over year, allocated $1.2 billion to buybacks during the quarter, and still has nearly $5 billion in remaining buyback authorizations.

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Capital distributions have exceeded cash flow over the past few years, and this obviously can't go on forever. However, IBM is going through a transformation, divesting its low-margin commoditized hardware businesses to better focus on software and services with superior growth prospects and higher profitability.

Whether the company can successfully accelerate growth remains to be seen. However, just because dividends and buybacks have grown at a faster rate than cash flow in the past doesn't mean capital distributions are necessarily unsustainable on a forward-looking basis.

Can IBM deliver?
Transformations are seldom easy and usually carry considerable costs. IBM's revenue has stagnated over the past few years, a valid reason for concern among investors in IBM stock and arguably the main reason the stock price is languishing in spite of growing cash flow distributions.

Not only is IBM moving away from some of its less promising businesses, but the industry is also changing. This is creating considerable challenges for IBM when it comes to adapting to the new trends. Cloud computing is hurting demand for IBM's servers and related software business, and the middleware and systems-management markets are going through considerable changes because of the rise of software-as-a-service.

On the other hand, management is betting on a series of businesses it has identified as "strategic imperatives" -- cloud, analytics, mobile, social, and security. These are areas with attractive growth prospects. Since IBM has deep and long-standing relationships with many big customers in the corporate world, management believes it can leverage its business know-how and industry-specific insights to outperform the competition and deliver superior solutions in these segments.

Revenue growth from the strategic-imperatives group of businesses has been in the neighborhood of 20% on a currency-adjusted basis in each of the past five years. Performance even accelerated in the first quarter of 2015, with constant-currency sales from these segments growing 30% year over year.

IBM produced nearly $25 billion in revenue from its strategic imperative businesses in 2014, and management believes those segments can generate $40 billion, or about 40% of the company's revenue, by 2018. This is clearly an ambitious target, but it doesn't sound unreasonable considering current trends.

Also, the company has recently announced that it will invest $3 billion over the next four years to establish a new Internet of Things unit. Management believes this could be a transformational opportunity for IBM, as the company stands to profit from this revolutionary technology on the back of its massive amounts of data, superior cloud capabilities, and unique engagement strengths.

Leaving financial forecasts aside, everything seems to be indicating that high-growth businesses will become an increasing part of the overall revenue mix for IBM in the coming years, and this should be a major positive when it comes to accelerating growth.

If these things happen, and the company can reignite sales and cash flow growth, IBM would prove to investors that it has what it takes to sustain its rapidly growing dividends and generous stock buybacks over the long term. This could produce big gains for investors in IBM stock.

The article IBM Increases Dividend 18%: What You Need to Know originally appeared on Fool.com.

Andrs Cardenal owns shares of Apple and International Business Machines. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and International Business Machines. 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.