IBM: An Undervalued Dividend Stock to Buy?
We are off to the races with another dividend stock analysis. In today’s article, we will review the famous technology company: International Business Machines (IBM). We will review IBM, the company’s recent earnings, news and run the company through our dividend stock screener to determine if IBM is an undervalued dividend stock to buy.
IBM: About the Company
International Business Machines (IBM) is one of the legacy technology companies. The company was at the forefront of technological change throughout the Cold War, and thereafter. After all, who doesnt’ know about the famous Watson supercomputer?
Today, IBM has transformed into a major player in the cloud hybrid and artifical intelligence sectors. Let’s also not forget about the company’s legacy technology business as well.
As of 12/31/20, the company reported revenue over $73b for the full fiscal year. That is billion with a B. To say the company is a large technology company is an understatement.
IBM transformed in 2019 with the acquisition of Red Hat. The company’s $34b acqusitition helped drive the company’s push towards becoming a major player in the hybrid cloud sector. As you will see later in the article, this is acquisition will be instrumental for the future growth of the company.
IBM: Major News & Updates
In this section, I will review two major storylines for IBM. The company’s latest results per their earnings release and the company’s announced spin-off. Let’s start first with the earnings release.
IBM’s Last Earnings Release
IBM last released earnings in January 2021. The results were mixed. The company continued its trend of declining revenue. Annualized revenue was down 6% compared to last year. Further, the company’s major segments, including cloud, saw declining revenues as well. This was particularly interesting given the company’s acquisition of Red Hat and push towards cloud services.
The declining revenue is a trend that is concerning to analysts and pundits that cover the company. After the large acquistion of Red Hat, you do not want to see the company’s top line revenue growth take a turn south. That is why these pundits are so down on IBM.
Despite the negative news, the one thing that jumps out to me about IBM, when reading its earnings results, is the company’s ability to generate cash. In the fourth quarter, IBM’s free cash flow was over $6b. Their total cash flow for 2020 was $10.8b. The positive cash flow for the year helped push IBM’s cash balance to over $13b!
Within the earnings release, management also discussed the company’s full year 2021 guidance. The company’s expected free cash flow is between $11b to $12b. If you ask me, that is still a lot of additional cash coming in the door. Cash that can be used to pay down debt, increase its dividend, or even, acquire anotehr company to help grow revenue.
IBM’s Upcoming Spin-Off
IBM made major shockwaves in the 4th quarter when the company announced a major spin-off. The company is going to spin-off its legacy, infrastructure business into a new entity. The slimmed down IBM, after completion, will focus on the company’s hybrid cloud business and AI.
We have seen this play before with large companies. Rather than continue as one massive company. Management will spin-off the company’s legacy, low growth business into one entity and keep the high growth entity in another entity.
This move will allow the two entities to focus on what they specialize in and deliver value to shareholders in their respective manner. The spin-off is expected to close at the end of 2021.
It will be VERY interesting to see what happens with the company’s dividend post spin off. We are hoping that the dividend will be split among entities and the total of the two separate dividends is greater than or equal to IBM’s pre-split dividend. As a dividend investor, the last thing you want to see is a dividend cut!
Dividend Diplomats Dividend Stock Screener
Now, it is time to run IBM through the Dividend Diplomats Dividend Stock Screener. We use 3 SIMPLE metrics to evaluate every dividend stock to determine if the company is currently an undervalued dividend stock to buy.
Watch: Our Simple, 3 Step Stock Screener
The 3 simple metrics include:
1.) Price to Earnings Ratio Less than the S&P 500. Currently, the S&P 500 is trading at insane levels. It has “kissed” a P/E Ratio of 40x. These levels are absolutely insane, given the market historically trades closer to 20x. No wonder it is so difficult to find an undervalued dividend growth stock these days!
2.) Dividend Payout Ratio Less than 60% (Although we think a perfect payout ratio is 40% – 60%).
Read: Dividend Aristocrats with a PERFECT Dividend Payout Ratio
3.) History of Increasing Dividends. We review this metric by reviewing the company’s five-year average dividend growth rate and dividend increase history.
Bonus: Dividend Yield. We like to also throw in a bonus metric to our dividend stock analysis.
How Does IBM Perform in Our Screener?
This analysis should be particularly exciting due to the fact that IBM operates in the hottest sector: technology. Let’s see if IBM is riding the momentum of the other hot technology stocks, or if the company is trading at a discount since they are considered a “legacy” technology company.
For this analysis, we will use IBM’s stock price $130.62 (3/24/21 close). Analysts are projecting forward EPS of $11.02 per share. The company’s annual dividend is $6.52 per share. Now that we have the inputs for our analysis, let’s dividend into the results. Time to run IBM through our dividend stock screener!
1.) Price to Earnings Ratio: 11.85x.
2.) Dividend Payout Ratio: 59%.
3.) History of Increasing Dividends: IBM became a Dividend Aristocrat in 2020. The company announced its 25th consecutive dividend increase in 2020. They are now one of the few technology companies to join this exclusive club. This is particularly important for the sector, as this means IBM increased its dividend through the tech bubble, financial crisis, and global pandemic!
Watch: What is a Dividend Aristocrat?
However, IBM’s recent dividend growth rate has not been overly impressive. Their 5 year average dividend growth rate is 4.66%. Further, their dividend increase in 2020 was underwhelming. The company increased is quarterly dividend from $1.62 per share to $1.63 per share. This was only a .6% dividend increase. This is well below inflation.
4.) Dividend Yield: 4.99%. IBM has a very solid dividend yield. The 4.99% dividend yield is over 2.5x the average yield of the S&P 500 and crushes the yield on your high yield savings account.
Upon review, IBM appears to be an undervalued dividend growth stock. The question is….am I buying shares? Currently, my wife and I own over 43 shares combined of the technology company. This position has a market value of over $5,600! This represents less than 1% of my dividend stock portfolio, as shown on our website. Therefore, the company represents less than 1% of my overall portfolio.
I will be adding IBM to my watch list. To me, their dividend increase in April is going to tell a major story. IBM has slowing revenue and slowing dividend growth. The company is a cash cow and generates strong cash flow, and management is taking steps to unlock the company’s value. However, those are trends worth keeping an eye on to see if they can turn around.
Since IBM will be increasing their dividend in April 2021, I want to see what managment does with the dividend before making another purchase decision. If the company announces another sub-1% dividend increase, I will remove IBM from our watch list. However, if the company shocks us all with a strong dividend increase, I will consider adding to my position (assuming the company still shows signs of undervaluation).
What do you think about IBM? Are you buying shares of IBM at its current valuation? Or are you waiting to read about the company’s upcoming dividend increase, like me? Looking forward to your responses!
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