IBM Is Now a Slightly Better Dividend Stock

Tech giant International Business Machines (NYSE:IBM) has been undergoing a turnaround effort for the better part of a decade. The company has dumped legacy businesses, invested heavily in cloud computing and artificial intelligence, loaded up on debt to acquire software company Red Hat for $34 billion, and announced a spinoff of its $19 billion managed infrastructure services business.

IBM’s strategy, which revolves around hybrid cloud computing, makes sense, and it has the potential to drive revenue and earnings growth in the years ahead. But to get to this point, IBM has subjected investors to years of revenue and earnings declines. The stock hasn’t fared well, either. Shares of IBM are down around 33% from their all-time high.

Through all of this, IBM has kept growing its dividend. The company announced its latest increase on April 27, bringing its streak of annual dividend hikes to 26 years. The company has paid quarterly dividends uninterrupted since 1916, an incredible track record.

IBM’s new quarterly dividend is $1.64 per share, just $0.01 higher than the previous dividend and good for a dividend yield of roughly 4.5%. That’s a token raise for sure, meant to keep the dividend growth streak alive as IBM mounts a comeback. The dividend boost doesn’t change the story much for dividend investors, but it does make the stock a bit more attractive.

A safe high-yield dividend

While IBM has looked like a disaster in recent years, at least according to the stock price, the company continues to generate a ton of cash. IBM expects to produce free cash flow, adjusted for some one-time items, between $11 billion and $12 billion this year. The company is valued at less than $130 billion if you want a sense of how pessimistic the market is pricing the stock.

That cash flow will help IBM continue to pay down its debt following the Red Hat acquisition, but it will also support the dividend. Based on the current share count, IBM will pay out about $5.9 billion in dividends this year. That’s roughly half of the high-end of IBM’s free cash flow estimate.

IBM has remained a cash machine despite the pandemic and its negative effects. The company managed to produce $10.8 billion in free cash flow last year even as some clients pulled back on spending. Revenue was down 5% for the year and earnings per share plunged, but even a pandemic couldn’t fully derail IBM’s cash flow.

A stable of longtime clients, long-term contracts, and extremely sticky products like the mainframe helped IBM weather the storm reasonably well. While dividend growth won’t pick back up until IBM returns to sustainable earnings growth, the dividend looks safe.

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Once the company completes its managed infrastructure services spinoff this year, IBM will no longer derive a majority of its revenue from services. Instead, the bulk of revenue will come from cloud software and solutions, and more than half of revenue will be recurring in nature. The shift to high-margin software should help drive the bottom line higher in the years ahead and support continued dividend increases.

While IBM’s turnaround is still a work in progress, a 4.5% dividend yield and the prospect of some serious stock price appreciation if the turnaround pans out are some pretty good reasons to own IBM stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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