- IBM has gotten quite a bit of media flack for its lack of revenue growth in recent years.
- However, static revenue growth does not translate to stagnant earnings or per share growth; and it certainly does not automatically stifle dividend growth.
- As a consequence, this article details the power of IBM’s dividend on the company’s future: either a much higher current yield or solid capital appreciation will result.
With International Business Machines (NYSE:IBM) set to report in the coming days, investors and speculators alike are eager to see how "Big Blue" performed over the last 90-day period. Sure to be a focal point is the company's recent revenue "woes." Objectively, it is true that last year's revenue was at the same level as 2010's number. So "static," in reference to revenue growth, isn't necessarily inaccurate.
Yet keep in mind two countervailing factors: revenue growth equals neither earnings growth nor per share growth. There's a reason companies don't just report how much they sold. While it is true that revenues have been largely stagnant, this does not hold true for other metrics. For instance, since 2010 net income has grown from $14.8 billion to $16.5 billion. Likewise, "operating income" has jumped from about $15 billion to $18 billion. Most to the point, earnings per share has increased at a 9% rate, moving from $11.50 to about $15.
In other words, the phrase "static revenues" might be accurate, but it's incomplete; it doesn't tell the whole story.
Incidentally, Tim McAleenan Jr. recently wrote an article detailing this exact subject. Moreover, it seems that Warren Buffett's wish for a "languishing" IBM share price (as the business continues forward) has largely materialized. Both sources are solid places to confirm your IBM investment rationale.
However, this article is intended to take a slightly different focus: a spotlight on IBM's dividend.
You can debate about revenue growth, competitive advantage, how the company is reaching its profit goals, the potential success or tribulations of an industry, all of it. And you can certainly quibble over the likelihood, sustainability and magnitude of future payments. Yet once the assumptions are formalized, the resulting math often speaks for itself.
We'll work through an example to see what I mean.
Shares of IBM presently trade hands around $190. Add in the $4.40 annual dividend and an EPS number in the $15-$16 vicinity (depending on GAAP or "operating" numbers) and you have a resulting "current" dividend yield of about 2.3% with a corresponding P/E ratio in the 12-13 range. (Additionally, this also requires the payout ratio to be just under 30% as well.)
Estimates for this year's earnings are in the $17-$18 range. Let's call it $17.60 for illustrative purposes - and not just $17.60 for this year, but we can keep that number the same indefinitely. Now here's the second assumption: imagine IBM pays out 50% of its profits in the form of a dividend in the future.
Certainly, a payout ratio move from under 30% to 50% is a big jump; and it obviously wouldn't happen overnight. Yet consider two factors: IBM devotes 3-4 times as much cash to repurchases rather than dividends and the payout ratio has still doubled over the past decade. It is true that there is a limit to the payout ratio expansion, but it's definitely within the realm of possibility - IBM has the cash flow ability to do it.
So, just for argument sake, let's say that IBM pays out an $8.80 per share dividend sometime in the future. If this were to take 5 years, that would require a 15% annual growth rate - roughly in line with what the company accomplished in the previous 5 years. If $8.80 per share is reached in 10 years, that would require a 7% growth rate.
So what are the implications of an $8.80 IBM dividend? That's a good question and I'm glad you asked. The way I see it, one of three scenarios results. The first would be IBM's share price continues to "languish"; remaining the same or even decreasing. For the current investor, this would mean a yield on cost of at least 4.6% and could actually be a good thing for the long-term net buyer who continues the course.
For the future investor, that could mean an initial 4.6% yield (or higher) sometime in the future.
Of course, many might clamor that IBM probably won't have a 4.6% dividend yield in the future. As such, the P/E ratio has to expand to provide a lower yield. For instance, if you believe IBM will have the same 2.3% yield as it does today, this equates to a future price of about $380 ($8.80 / .023). Expressed differently, if the dividend amount doubles and the yield remains the same, the share price must also double - 100% upside.
In reality, the eventual truth would likely be somewhere in between the first two scenarios: say a 3% yield and a corresponding 16.7 P/E ratio. Interestingly, this would still equate to yearly gains on the order of about 11% per annum over the next half decade. And obviously, if you did have any revenue or earnings growth, these numbers might swing to the upside.
What's interesting - and perhaps compelling - to me is the idea that an $8.80 dividend for IBM is totally achievable. In fact, the company returned nearly double that amount in the form of dividends and share repurchases last year ($3.70 in dividends, roughly $12.50 in buybacks).
If IBM reaches the $8.80 payout mark, it leads to some shareholder friendly options. Don't believe the company will yield 4.6%? Well, that means the price has to increase. Don't believe IBM will trade at 20+ times earnings? Well, that requires a higher reinvestment yield. Either way you slice it, a higher yield, a higher price or both are likely in the future for IBM. (And not just higher, but perhaps substantially higher.)
Incidentally, I would surmise that this math is the same reason that you rarely see Coca-Cola (NYSE:KO) or Procter & Gamble (NYSE:PG), for instance, trading around 15 times earnings. Such a multiple would simultaneously require a current yield in the 4% range. IBM might eventually be quite similar, just a few years behind.
Here's the bottom line: when it comes down to it, I have no idea whether or not IBM's revenues will grow, decline or even remain stagnant for the next decade. Surely many will be focused on this aspect in the company's upcoming report, but I have no specific insight in this area. What is possible to determine is that IBM has the ability to increase the dividend payment substantially, regardless of the intermediate-term revenue prospects. As a consequence, one of three shareholder-friendly scenarios will likely come to fruition. The most likely is unknown, yet it's clear that the combination of a reasonable yield and a low payout ratio spell opportunity.