Buy IBM for high and growing dividends

U.S. global blue chip tech stock IBM is growing its profits in newer businesses to offset declining profits in older businesses. Its earnings per share are expected to grow next year. The company’s shares remain a buy for attractive and growing dividends while you wait for price gains.

International Business Machines (NYSE—IBM), or IBM, earned less money in the first half of 2016. This Armonk, New York-based U.S. Key stock is expected to earn less in all of 2016. Next year, however, the company’s earnings are expected to resume rising as it continues to transform itself. IBM will keep raising its attractive dividends. This should lead to long-term share price gains. As a result, IBM remains a buy, despite risk that the execution of the transformation strategy could go awry.

In the six months to June 30, IBM earned income from continuing operations of $5.105 billion, or $5.30 a share. This was down by more than 21 per cent from $6.680 billion, or $6.75 a share, a year earlier.

IBM’s high dividend keeps getting better

Even so, IBM is optimistic about its outlook as it shifts gears for future growth. That’s why earlier in 2016 the company raised its dividend by 7.7 per cent, to $5.60 a share. This provides an attractive yield of more than 3.4 per cent. IBM has doubled its dividend since 2010. It has also increased its dividend for 21 years in a row. With cash of $10.017 billion, marketable securities of $600 million and a safe net-debt-to-cash-flow ratio of 1.7 times, we expect IBM to keep raising its dividend.

Chair, president and chief executive officer Ginni Rometty said: “IBM is transforming its business into a cognitive solutions and cloud platform company. Our strong profit and cash flow performance allow us to make the investments required to drive this transformation, while continuing to return significant capital to shareholders.”

IBM is investing heavily in its growth

Senior vice-president and chief financial officer Martin Schroeter said: “In the first half of 2016, we grew our R&D [or Research and Development] investment, closed 11 acquisitions for more than $5 billion and invested nearly $2 billion in capital expenditures, while returning more than $4 billion to shareholders through dividends and gross share repurchases. These investments are helping us build new markets and maintain our leadership in enterprise IT [or Information Technology].” The facts confirm Mr. Schroeter’s statement.

In the first half, IBM’s investment in research and development climbed by 12.5 per cent, to $2.923 billion. Such investment is critical for companies that operate in the tumultuous technology industry. IBM also raised its investment in capital expenditures, to $1.949 billion. The company complemented its own investment with acquisitions. In the first half, it spent a net $5.370 billion in acquisitions.

In the first half, IBM paid dividends of $2.590 billion and bought back $1.775 billion of its shares. It’s authorized to spend up to $3.9 billion more on repurchasing shares. To the extent that the company buys back it shares, it increases its earnings per share, all else being equal.

All these expenditures exceeded its first-half cash flow of $8.557 billion (excluding changes in working capital). It covered this shortfall partly by borrowing $3.929 billion. On the positive side, the cash flow was up by nearly a half, from $5.773 billion, a year earlier. This largely reflects the addition of cash flow from past acquisitions.

Replacing high tech with newer high tech carries risks

IBM is in a sort of race between its growing and declining businesses. So far, its declining businesses have had the upper hand. In the first half, the company’s total revenue slipped by 3.7 per cent, to $38.929 billion. Only its Cognitive Solutions and Other segments generated higher revenue. This only partly offset lower revenue from its Global Business Services, Technology Services & Cloud Platforms, Systems and Global Financing segments.

Ms. Rometty noted that, “In the second quarter we delivered double-digit revenue growth in our strategic imperatives.” Specifically, second-quarter revenues from the company’s strategic imperatives climbed by 12 per cent compared to a year earlier. Also, its intellectual property and custom development jumped, though from a low base. All this bodes well for future earnings per share growth.

In 2016, IBM expects to earn “at least” $13.50 a share. Preferring to err on the side of caution, we’ve used this as our earnings estimate. This would represent an earnings per share drop of 9.5 per cent, from $14.92 a share last year. On the positive side, this estimate works out to an appealing price-to-earnings, or P/E ratio of only 12.1 times.

Next year, IBM’s newer businesses are expected to gain the upper hand. The company is expected to earn $13.96 a share. That would represent earnings per share growth of 3.4 per cent. This is slow growth of course. But at least it’s going in the right direction—up. Based on this estimate, IBM trades at a better P/E ratio of 11.7 times.

 

The Investment Reporter, MPL Communications Inc.
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