IBM: Don’t Let The Yield Fool You, It’s Not Worth The Risk

Summary

IBM’s high dividend yield of 5.4% may distract investors from the company’s underlying dynamics.

Anemic sales and earnings growth may lead to more trouble for the dividend in the future.

Despite the change in leadership, IBM looks to be faced with the same challenges from the past decade.

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Charday Penn/E+ via Getty Images One of the more popular holdings among dividend investors has been International Business Machines Corp. ( IBM ). This was due to the company’s industry leading innovations that fueled both impressive stock price growth and a hefty dividend. Regrettably, over the past decade, IBM’s innovation engine faltered. As a result, revenues shrunk and the company’s dividend growth rate declined dramatically. Today, investors should be wary of the company’s 5%+ dividend yield as the company may be forced to cut the dividend to a sustainable level if growth does not pick up soon. In our view, as one looks to do some portfolio positioning at the end of the year, IBM is one position to steer clear as the yield is not worth the risk. Introduction

IBM has been a popular dividend stock to own for generations. Over the decades, IBM’s positioning as a cutting-edge technology firm led to great gains and cashflows for shareholders. Unfortunately, the tech giant’s CEOs over the past decade have not been able to keep up with the changes in technology. As a result, IBM is no longer the innovator that it once was. For dividend focused investors, the current yield of 5.4% should be carefully evaluated as it may not be here for long. Taking A Hard Look At The Dividend

IBM’s current dividend yield of more than 5% is impressive in nearly any environment. Considering that today the S&P 500 Index yields little more than 1.3%, and the more than 400 basis point (4%) difference is impressive. Adding in that the company has grown its dividend for 22 consecutive years , and one would assume that IBM is a great source of equity income. Unfortunately, this is not the case when digging deeper into the company’s dividend history.

Although IBM has grown its dividend for more than 20 years, this growth has been slowing dramatically over the past decade. What once started out at $0.10 per quarter in dividend growth for 2012 (increased from $0.75 per share to $0.85 per share to shareholders each quarter) rose to an impressive growth of $0.15 in 2014 and $0.20 in 2015. Unfortunately, with business growth lagging, management opted to return to $0.10 in growth for the next two years. As the business growth continued to be elusive at the end of the past decade, this rate shrunk to ultimately $0.01 for 2020 and 2021. IBM’s Quarterly Dividend per Share Growth – Past 10 Years

Source: Seeking Alpha .

In our view, the cause of the declining growth of IBM’s dividend was the company’s focus on business growth through acquisition. Under the management of former CEO Ginni Rometty (2012 – 2020), the company made 65 acquisitions , the largest of which was Red Hat. Given the size of IBM’s operations and limited amount of innovation within the company, growing through acquisition appeared to be a reasonable approach. Unfortunately, this also put a strain on the company’s cash flows. Although the initial impact of these acquisitions was positive, and the dividend grew at faster rates, ultimately the company needed to slow their dividend growth to maintain their pace of acquisitions.

The approach seemed to be working until 2018 as the company had been able to continue to grow their dividend while also maintaining a payout ratio near 30%. This changed when the company hit a stretch of revenue misses starting with 3Q 2018. For the following four quarters the company missed revenue expectations. Worse yet, revenues generally declined on a year over year basis for nearly every quarter until the start of 2021. As the management team pushed to keep growing the dividend annually, albeit at decreasing rates, they also had to boost payouts (see table below).

IBM’s Payout Ratio is Reaching Danger Territory Data by YCharts For us dividend focused investors, payout is paramount. In general terms, we view payout as the percentage of the company’s earnings that is distributed to shareholders. If nearly all the earnings for a company are distributed through dividends, there is little room to fund […]

source IBM: Don’t Let The Yield Fool You, It’s Not Worth The Risk