International Business Machines Corp.: A Great Dividend Stock at a Low Price

By Markets Fool.com

After its recent earnings report, shares of International Business Machines tumbled. It's been a tumultuous couple of years for IBM as it transitions its business to the cloud, and its results have been choppy. Shares of IBM now trade below $160, down about 20% from a recent high reached in early 2013.

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IBM's stock declined, but the company's dividend keeps on growing. Over the past decade, IBM has hardly been a great dividend stock, with yields typically below 2%. But over the past 18 months, IBM's dividend yield has shot up to decade highs, on par with other technology giants. Ironically, the increased yield is largely a function of the share weakness.

With a high dividend yield, now about 3.25% based on the most recent dividend payment, and plenty of room for further dividend growth, IBM has become one of the most attractive dividend stocks in the technology sector.

Finally an attractive dividend
IBM has typically favored share buybacks as a means to return cash to shareholders. The dividend, while growing quickly over the past decade, has never represented a high percentage of IBM's earnings or free cash flow. This has resulted in a dividend yield that has been lower than that of other large technology companies.

But IBM's falling stock price, along with continued growth in the dividend, has changed the story:

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Sources: IBM and Yahoo Finance

Over the past decade, IBM's annual dividend payments have grown at a compound annual growth rate of just over 20%. The most recent dividend increase, an 18.2% bump that came earlier this year, was right in line with this historical rate.

With a 3.25% dividend yield, IBM is now an attractive dividend stock compared with other large technology companies.

Company

Dividend Yield

IBM

3.25%

Microsoft

2.73%

Apple

1.69%

Cisco

2.98%

Intel

3.39%

Source: Morningstar.

Of course, the dividend yield is only half of the equation. Future dividend growth is the other half, and IBM has plenty of room to rapidly grow its dividend in the years ahead.

Plenty of room to grow
Share buybacks have eaten up quite a bit of IBM's cash flow in recent years, but the company has recently signaled that it would slow the pace of buybacks down. In its investor-day presentation, IBM guided for a 2% to 3% reduction in shares annually, and with 75% of its free cash flow expected to be returned to shareholders each year, this creates a runway for further dividend growth.

IBM will pay out $5.20 per share in dividends over the next year, based on its most recent dividend payment. The low end of IBM's non-GAAP earnings guidance calls for $15.75 per share, putting the payout ratio based on this number at a measly 33%. Based on free cash flow from last year, which IBM expects to grow modestly this year, the payout ratio is a higher 41.5%.

Free cash flow is currently depressed relative to net income, but in the long run, IBM expects its free cash flow to be around 90% of net income in any given year. Regardless, a payout ratio between 30% and 40% can certainly be expanded, especially with a lid being kept on share buybacks.

Even if earnings remain stagnant for a few years as IBM's transition carries on, double-digit dividend growth can continue. Eventually, earnings growth will limit dividend growth, but in the long run, IBM expects to return to high-single-digit earnings growth if everything goes according to plan.

A great dividend stock
IBM's results are going to be choppy as the company continues its transformation, and this choppiness has generated quite a bit of pessimism surrounding the stock. This has pushed the stock price down, and IBM's dividend yield is now on par with other large technology companies. Along with a history of rapid dividend growth and room to grow the dividend further, there's a lot for dividend investors to like.

The article International Business Machines Corp.: A Great Dividend Stock at a Low Price originally appeared on Fool.com.

Timothy Green owns shares of Cisco Systems and International Business Machines. The Motley Fool recommends Apple, Cisco Systems, and Intel. The Motley Fool owns shares of Apple, Intel, and Microsoft. 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.