If you're looking to buy a partial ownership stake in
a publicly-traded company, then there are a number of things that
you should consider before doing so. These things include the
company's business model, historical earnings growth and corporate
governance. Another thing that you may want to consider is the
Dividends are very important as they can provide
some cushion for investors to the downside and can also signal
confidence from management in the company's future. Many investors
pursue dividend-paying stocks to augment their returns with a nice
income stream. Most of them prefer to diversify into many different
sectors of the economy in order to spread out their risk.
Today, let's take a look at IBM,
a huge player
in the technology sector of the economy. Let's see how the dividend
of IBM stacks up in terms of strength and
sustainability and what investors can expect going forward.
The first and most obvious consideration when
evaluating a company's dividend is the dividend yield, which
represents the percentage of your investment that you'll receive
back over the next 12 months at current share prices and dividend
yields 1.9%. This yield is based on the dividend payments that have
been made over the last 12 months. The company is expected to
announce a dividend increase at the end of April, as they have done
over the last several years. While the company's dividend yield is
currently small, it should go up after the dividend increase. We
should also keep in mind that the company's dividend yield is near a
five-year high of 2.2%. Over the last five years, the dividend yield
has ranged between 1.4% and 2.2%.
When analyzing a dividend, it's not all about the
yield. As an income investor, you want that dividend to grow over
time in order to protect your income stream from the erosive effects
of inflation as well as to show confidence from management in the
Table 1: Dividend
Growth Rates from IBM
Table 1 shows strong
double-digit dividend increases from IBM over the last several
years. In fact, IBM has increased its dividend at a double-digit
rate every years since 2004. The company has increased its dividend
every year for the last 18 years. IBM has paid dividends every year
Free Cash Flow Payout Ratio
While high dividend yields and strong dividend growth
are nice, we need to make sure that the company in question can
generate enough cash flow to cover its dividend payment. The free
cash flow payout ratio tells us what percentage of the company's
free cash flow is eaten up by dividend payments. Lower free cash
flow payout ratios are better as they leave more room available for
future dividend increases or other uses of the capital.
Free cash flow is the cash flow a company generates
in its operations minus capital expenditures.
Table 2: Free Cash
Flow Payout Ratios of IBM
Table 2 shows that the dividends from IBM are in very
good shape, as they are currently consuming just over one-quarter of
free cash flows. This leaves the door open for strong future
dividend increases along with other value-creating activities.
From looking at the company's free cash flow payout
ratio, it can be concluded that the dividend is in no danger at this
point in time.
Interest Coverage Ratio
One of the ways in which we can determine whether or
not a company will have trouble paying its dividend in the future is
by looking at how much interest it has to pay every year. More money
spent on interest means less money that is left for dividends. To
determine the effect that debt has on a company's ability to pay its
dividends and fund other activities, I calculate the interest
coverage ratio. This ratio is calculated by dividing the company's
earnings before interest and taxes by its interest payments over the
year. You generally like to see this ratio at or above 2. If it's
below this figure, then that may signal trouble ahead for the
company in question.
Fortunately, this is not a
problem at all for IBM. Its earnings
before interest and taxes over the past 12 months
its interest obligations almost 50 times! At this point, debt is
not having an effect at all on the company's ability to pay its dividends.
Earnings Per Share Growth Forecasts
While it's good to look at what
past dividend payouts have been and how they relate to past
earnings, we need to get an idea as to what future dividend payouts
are going to look like. One of the ways in which we do this is by
looking at analyst forecasts for earnings-per-share growth. This
year, analysts expect IBM to increase
its earnings per share by 4.9%, followed by an 11% increase in 2015.
It should be mentioned that these projections are based on non-GAAP
The current dividend of IBM is well-covered by its
free cash flow. The company has shown a strong
commitment to returning cash to shareholders through its 18-year
streak of dividend increases, and its 101 years of dividend payments.
The company's free cash flow payout ratios over
the last several years show that IBM should have no problem in
continuing to increase its dividend at a double-digit rate in the
near term. Analyst estimates that call
for earnings per share growth in the high single-digit to low
double-digit range reinforce this notion.