- The notion that IBM needs to grow revenues in order to be a successful investment is a myth that underestimates the extent of the company's buyback.
- Even though revenues have declined 3-4% in total since 2008, the company has still managed to grow profits per share by over 60% and raise dividends by over 90%.
- Despite lower revenues entering 2014 compared to 2008, IBM has still managed to return 8.84% annually.
If you have been following IBM (NYSE:IBM) for the past two years, you have no doubt encountered fair criticism about the company's difficulty in growing revenues. The conventional view regarding IBM seems to have been summed up succinctly by Therese Poletti at Marketwatch when she observed the following:
IBM Corp.'s revenue has declined for eight consecutive quarters, but it steadfastly continues to maintain a strong earnings outlook for both 2014 and 2015, even as analysts have become more skeptical that the company will deliver.
From my vantage point, everyone seems to be beating around the bush regarding the relationship between IBM's ability to grow revenue and IBM's ability to be a successful investment, so I'll just come out and say it: IBM does not need to grow revenues in order to deliver satisfactory returns. Sure, increasing revenue figures would facilitate profit growth, and substantially declining revenue figures would become problematic, but stagnating revenues for a long period of time is not necessarily at odds with IBM's ability to create long-term wealth for shareholders.
In my opinion, the financial media has performed inadequately in pointing this fact out. Just look at IBM's recent history over the medium term. In 2008, IBM generated $103.6 billion in total for shareholders. By the end of 2013, that figure declined a bit to $99.7 billion (and the estimates for 2014 are for a slight drop-off from 2013's figures). Given the fact that IBM is now generating less total revenue than it was six years ago, you'd expect business results for shareholders to be terrible given the inability to grow revenue, right?
No, that has not been the case. IBM's ability to reduce shares substantially through its buyback have acted as a strong, permanent countervailing force that has diminished the effects of revenue declines. In 2008, IBM had 1.34 billion shares outstanding. Right now, IBM has 1.01 billion shares outstanding. Because each share now represents 24% more ownership than it did in 2008, IBM has been able to easily absorb a revenue decline of 3.76% in total (not annualized) since 2008.
The increase in profits per share, as well as the manifestation of that profit per share growth through an increasing dividend, has been significant since IBM's revenue has struggled to grow since 2008. Back in 2008, each share of IBM represented $8.93 in profits per share. Because of the strong ongoing buyback, and increased profitability stemming from IBM's decision to lower costs, those $8.93 in 2008 profits per share have increased to $14.94 by the end of 2013. In other words, during the time 2008-2013 time frame in which total revenue decreased 3.76%, each share of IBM ownership is now reporting 67.30% higher profits, proving that revenue growth is not a necessary condition for IBM to demonstrate meaningful profit per share growth.
To reflect this profit per share growth, long-term holders have also been rewarded with significantly higher dividends, again during a time in which IBM was not able to increase its profits. The company paid $1.90 to shareholders in 2008, and then paid out $3.70 per share to IBM owners in 2013. The dividend payout ratio is still only 24.76% of profits. For those of you keeping score, the 3.76% total revenue decline from 2008-2013 was matched by 67.30% total profit growth and 94.73% total dividend growth, with a payout ratio that still allows IBM management to save a little over $0.75 on every dollar of profit to direct as they see fit for growing profits per share.
IBM seems to be a case where investors have created a false bogeyman by criticizing IBM's lack of revenue growth. That's not a barrier to success; the long-term concern would be sharply declining revenues in which a significant repurchase program could not offset collapsing profits. But that is not the case here, as IBM seems dedicated to increasing the overall efficiencies in its operations. You can see that in the operating margin that has increased from 16.8% in 2004 to 24.3% by the end of 2013. You can see that in the net profit margin that has increased from 9.0% in 2004 to 16.5% at the end of 2013. While it's easy to experience top-line growth to deliver value for shareholders, there are lots of ways to put money in the owner's pockets, and the combination of increased efficiencies and significant stock buybacks has been enough to overpower IBM's long-term issue of stagnating revenues.
While it's true that growing revenues would facilitate growth and declines in revenues would hamper growth, the notion that IBM *must* grow revenues in order to deliver satisfactory returns to investors is demonstrably false, as the recent 2008-2013 period shows. Even though revenue has declined 3-4% since then, we've still seen overall profits increase 67.30% and total dividends increase 94.73%. The sharp focus on revenues for IBM creates the impression that IBM's business model relies on revenue growth to be a satisfactory investment. No, it relies on a low dividend payout ratio that facilitates significant stock buybacks that can be a stronger counterforce to stagnating revenues so that investors can still reap adequate returns. That's why IBM has quietly returned 8.84% annually since 2008, even though the company reported higher total revenues back then.